BoE rate cut signals tentative recovery for UK economy

UK economy boost: The Bank of England's first interest rate reduction in over four years is sparking cautious optimism about Britain's beleaguered economy, though substantial challenges remain for the new government.

On Thursday, the BoE reduced its benchmark rate from a 16-year high of 5.25 per cent to 5.0 per cent. This aims to provide some relief to households and businesses still grappling with the inflationary impacts of the COVID pandemic and the fallout from Russia-Ukraine conflict.

UK manufacturing outperforms

Preceding the BoE’s announcement, data revealed that British manufacturers performed better in July compared to many counterparts across Europe and Asia.

Following the rate cut, British stocks experienced a boost. The FTSE 250 index, which tracks medium-sized firms, reached its highest level since February 2022, although it later dipped in response to concerns about the US economy.

For new Prime Minister Keir Starmer, who has prioritized economic growth through productivity-enhancing reforms, the rate cut and signs of recovery after last year's mild recession are promising. 

BoE Chief Economist Huw Pill, who voted to maintain current rates, acknowledged the improved outlook but cautioned against excessive optimism, noting that growth remains historically modest at around 1 per cent  annually between 2024 and 2026.

Michael Browne, chief investment officer at Martin Currie, part of Franklin Templeton, believes that further rate cuts by the BoE could bolster this tentative recovery. He emphasized that interest rate-sensitive sectors, such as house builders, real estate, utilities, and green energy, are likely to benefit.

Reasons for continued caution

The BoE’s decision came shortly after finance minister Rachel Reeves unveiled a significant public sector pay rise, marking the first step in her strategy to accelerate Britain's economic growth to 2.5 per cent  annually.

However, there are ongoing reasons for caution. The narrow 5-4 vote by the BoE's Monetary Policy Committee highlighted lingering inflation risks. Governor Andrew Bailey emphasized that the rate cut does not signal a series of rapid reductions in borrowing costs, as inflation concerns remain.

Suren Thiru, economics director at ICAEW, noted that while the rate cut represents a shift in policy, the financial pressures on households and businesses persist. Investors are only anticipating one more rate cut from the BoE later this year.

Wage growth outpaces target

Wage growth remains high at nearly 6 per cent , double the rate consistent with the BoE's 2 per cent  inflation target. Despite the BoE’s upgraded forecast for 2024 growth to 1.25 per cent  which puts the UK ahead of France, Italy, and potentially Germany the forecast for 2025 and 2026 remains unchanged at 1 per cent  and 1.25 per cent , well below pre-2008 crisis averages.