The Bank of England hinted at potential interest rate reductions, possibly as early as August, despite holding rates at 4.25% on Thursday. Inflation remains stubbornly high, exceeding the Bank’s target and prompting caution.
Governor Andrew Bailey indicated a gradual downward trajectory for rates, but acknowledged significant global uncertainty. The ongoing conflict in the Middle East, particularly its impact on oil-producing nations like Iran, poses a considerable risk of escalating energy prices and further inflation.
Deputy Governor Clare Lombardelli cited economic uncertainty as the primary reason for the rate hold, emphasizing careful monitoring of the Middle Eastern situation and its potential consequences for UK inflation. Since the last meeting, oil prices have surged 26%, and gas prices 11%.
While the Bank slightly revised upwards its UK economic growth forecast, it noted underlying weakness. Economic performance has been erratic this year, showing strong initial growth followed by a sharp contraction in April.
Encouragingly, wage growth is decelerating, unemployment is rising, and businesses are exhibiting hiring restraint. Governor Bailey highlighted these softening labor market indicators as key factors to observe for their impact on consumer price inflation.
The Bank’s base rate directly influences high street lending rates. Recent increases have elevated borrowing costs for mortgages and credit, while simultaneously boosting savings returns. Analyst Susannah Streeter of Hargreaves Lansdown anticipates two rate cuts this year.
She suggests the current pause reflects the complexity of the economic landscape. Market expectations for an August rate cut persist, offering potential relief to borrowers. Recent policy changes, including increased National Insurance contributions and minimum wage hikes, are estimated to have increased business wage bills by 10%, impacting pricing strategies.
Businesses are employing various cost-cutting measures, including moderated pay rises for lower-paid workers. The recruitment firm Hays, experiencing weakening demand, issued a profit warning, highlighting the challenging business environment.
Some businesses absorbed higher employment costs by reducing profit margins rather than passing them onto consumers through price increases. Inflation, currently at 3.4% (May figures), is projected to reach 3.5% before falling to approximately 2.1% next year. The Bank’s actions aim to maintain inflation near its 2% target.
Raising interest rates aims to curb inflation by discouraging borrowing and spending, thereby reducing demand. However, this approach carries the risk of harming economic growth through reduced business investment and job creation.
Separately, the government announced adjustments to the winter fuel payment scheme, extending benefits to 2.7 million more recipients. Falling energy prices under Ofgem’s new price cap will offer further relief.
Further details regarding welfare spending cuts and employment initiatives have been met with criticism from some Labour MPs.