Sunday, December 22, 2024

Bank of England expected to hold interest rates as investors await November cut

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The Bank of England (BoE) is all but certain to hold rates at 5% on Thursday, having cut in August for the first time in four years, but investors expect rate-setters will set the stage for a November cut.

Threadneedle Street is treading more carefully towards lower interest rates than the US Federal Reserve, which will announce its policy rate decision on Wednesday, with markets expecting Fed chair Jay Powell to deliver a 25 to 50 basis points cut.

“The tone of the August meeting and subsequent speeches have made it abundantly clear that officials don’t want markets running away with the idea that this is going to be a rapid easing cycle,” said James Smith, economist at ING.

Speaking at the Jackson Hole summit of central bankers in the US late last month, BoE governor Andrew Bailey struck a cautious note.

“The second round inflation effects appear to be smaller than we expected,” he said. “But it is too early to declare victory.”

Of 65 economists surveyed by Reuters, all expected the BoE to hold rates steady at 5%.

Investors are expecting a vote split, with dovish Monetary Policy Committee (MPC) member Swati Dhingra pushing for a cut.

“We anticipate Dhingra likely advocating for a 25-basis-point cut, while deputy governor Dave Ramsden might vote with the majority this time,” Althea Spinozzi, head of fixed income strategy at Saxo, said.

“This week’s BoE meeting will mark Alan Taylor’s first as he steps in to replace Jonathan Haskel. While his policy stance remains unclear, we anticipate that Taylor will vote in line with the majority at his first meeting,” she added.

Read more: Pound pushes higher against dollar as aggressive US interest rate cut expected

Deutsche Bank sees a 7-2 vote tally, with risks skewed to a 6-3 vote count for a hold.

Economists at Nomura said the BoE’s close 5-4 vote in August and healthy business surveys pointed to a hold next Thursday.

“We see the MPC skipping this month’s meeting and cutting interest rates again only in November,” they said, adding that the MPC’s Swati Dhingra was likely to be the sole voice for a cut this time.

August inflation data on Wednesday, the day before the BoE meeting, could affect investors’ expectations.

“The UK has still got much higher wage inflation, much higher services inflation and the best growth across the G10 for the first half of this year,” said James Rossiter, head of global macro strategy at TD Securities.

“It’s hard to envision a world where the MPC looks at that macro backdrop and thinks that they should be cutting as fast as the Fed.”

Although inflation was 2% in May and June, it rose slightly to 2.2% in July and is not predicted to drop back below target until at least 2026.

“Monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further,” the BoE said in the statement accompanying its 1 August rate cut.

“The [MPC] continues to monitor closely the risk of inflation persistence and will decide the appropriate degree of monetary policy restrictiveness at each meeting.”

Sanjay Raja, senior economist for Deutsche Bank, said that “despite cutting rates in August, the MPC struck a more cautious tone around inflation risks — something that will likely stick in September”.

He also thinks the Bank will keep rates the same on Thursday but then reduce them again in November.

Similarly, AllianzGI believes the BoE will leave the door open for future cuts. “We expect the BoE to signal its desire to ease policy further at subsequent meetings this year and into 2025,” said Ranjiv Mann, senior fixed income portfolio manager at AllianzGI.

Andrew Goodwin, chief UK economist for Oxford Economics, said most members of the Monetary Policy Committee are “likely to be content to sit back and reassess the situation in November, a meeting at which the MPC will update its forecasts to incorporate the impact of the budget”.

“We think that fiscal event will be the factor most likely to push the MPC off the gradual loosening path that it advocated in August,” he said, meaning it could start cutting rates more quickly.

Interest rate futures are pricing in two more cuts, in November and December, to put the end-year rate at 4.5%.

“Having multiple data points to really assess how fast and how speedy the disinflation narrative is building in the UK, that’s something we don’t think we will get until the November decision,” said the chief UK economist at Deutsche Bank.

Nearly 80% of economists polled by Reuters, 49 of 65, expected one more cut this year. While 48 predicted it in November, one said December. The other 16 saw two more rate cuts this year.

Meanwhile, the consensus numbers suggest three 25 basis points rate cuts this year for the Fed, with a further 125 basis points next year.

Read more: US Federal Reserve expected to cut and Bank of England set to hold interest rates

“Our view is 100bp of cuts this year with another 100bp next year. So, if they do a 25bp cut next week, that implies a 50bp move at either the November or the December FOMC meetings with 25bp of cuts at the first four FOMC meetings of 2025, leaving the Fed funds upper bound at 3.5%,” ING analysts said.

Analysis by research firm Capital Economics suggests that UK rates will hit 4% by the end of 2025.

“We have to be careful not to cut interest rates too much or too quickly,” it said in the 1 August statement. The BoE forecasts interest rates being around 3.5% in the latter half of 2027.

The BoE has been more cautious than other central banks in keeping interest rates high to bring down inflation, which has led to some criticism as higher borrowing costs squeezed UK households and mortgage holders.

The European Central Bank (ECB) has also moved faster than the BoE, after it cut interest rates in the Eurozone earlier this month — the second reduction in a row. The ECB’s rate-setting council lowered the main deposit rate from 3.75% to 3.5%.

Traders have ramped up their bets that the BoE could go with a bigger cut, but only if the Fed goes ahead with a more aggressive cut of 50 basis points.

Investors are pricing in around a 35% chance that the BoE will cut rates by 0.25 percentage points, according to London Stock Exchange Group (LSEG) data. this is higher than last week’s 20% chance. However, keeping rates at 5% is still the most likely and consensual outcome.

The BoE’s decision to keep rates steady at 5% will impact UK mortgage holders. Homeowners with variable or tracker rate mortgages should see their monthly payments remain at current levels, providing some relief from the uncertainty of further rate hikes.

However, those on fixed-rate mortgages may still feel the effects of previous increases when they come to remortgage, as lenders continue to factor in the current economic outlook and BoE policy.

Higher interest rates in recent months have led to increased borrowing costs, with many households seeing their mortgage payments rise substantially.

“Regardless, interest rates are expected to end the year at 4.5% — signalling two successive cuts before Christmas. That would be the best present that wannabe homeowners could get, with a mortgage rates war already hotting up. More interest rate cuts could put fire-starters under the housing market once again, which has already seen activity pick up since last month’s cut,” Laura Suter, director of personal finance at AJ Bell, said.

Read more: Gold hits record high as investors anticipate major US Fed rate cut

“Equally, a hold to interest rates this month might mean that some buyers decide to delay their house buying journey until later this year, in anticipation of lower interest rates,” she added.

Paul Heywood, chief data & analytics officer at Equifax UK warned that affordability issues will remain a problem without a rate cut.

“With house prices also at a two-year high, home buyers, whilst hopeful for another cut, will be grateful for no further rate increases and start to feel the benefit from relief in mortgage rates. Nonetheless, affordability remains a significant challenge for consumers, as average repayments on new lending remain 53% higher than levels observed in January 2022.

In a big week for central banks around the world, the Fed will announce its decision on Wednesday evening, UK time.

Elsewhere, Brazil’s central bank is scheduled to hold its next policy meeting across Tuesday and Wednesday. Norway’s Norges Bank and South Africa’s Reserve Bank will all follow on Thursday.

The week of central bank decisions will culminate on Friday, when the Bank of Japan (BoJ) wraps up its two-day meeting.

The Bank of England will announce its decision on Thursday at noon in what will be the last MPC meeting before the autumn budget, due 30 October.

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