Interest rate cut in doubt even as UK inflation remains at Bank of England target

The markets were all but certain that the Bank of England (BoE) would cut interest rates in August, with the Bank previously hinting that this would be the case. However, hopes of a summer interest rate cut have been knocked after inflation proved more stubborn than hoped last month.

Interest rates have been kept at a 16-year high of 5.25% in an attempt to slow consumer prices rising, but higher rates have pushed up the cost of borrowing, including for mortgages.

With inflation finally hitting the Bank's 2% target in May, markets were almost certain of a summer rate cut. However, the fact that inflation stayed at 2% in June, defying forecasts of a further dip, has pushed investors to pare expectations of an August rate cut.

Money markets indicate there is a less than 25% chance of the BoE cutting interest rates next month after inflation held firm at 2%.

Traders have sharply reduced their betting on a lowering of borrowing costs at the next meeting of the Monetary Policy Committee (MPC) on 1 August.

On Tuesday, the chances of a rate cut stood at about 49%, down from 51% at the end of last week.

Also pouring cold water on City predictions, the BoE's Jonathan Haskel recently said inflation was on course to return above the BoE’s 2% target.

“I would rather hold rates until there is more certainty that underlying inflationary pressures have subsided sustainably,” said Haskel, a member of the Bank’s MPC, in a speech at King’s College London on Monday.

Haskel is an external member of the MPC, with his term due to end on 31 August. While some members of the Bank’s nine-strong MPC have pushed for a cut in official borrowing costs over recent months, Haskel has voted to keep rates on hold.

Read more: UK grocery inflation at lowest level in nearly three years

"The playing out of those shocks through the economy, and the continued tight and impaired labour market, means that inflation will remain above target for quite some time," Haskel said.

Bank governor Andrew Bailey has previously emphasised inflation must be sustainably close to target before the Bank acts.

Significantly, closely watched services inflation, which tracks categories such as hospitality, culture and housing, was unchanged at 5.7% in June, which was higher than economists’ estimates.

The core rate of inflation, which strips out energy, food, alcohol and tobacco, stayed at 3.5%.

Experts have cautioned that a rate cut this summer could be less likely until the majority of the MPC feel certain that inflation is under control.

Peter Arnold, EY UK chief economist, said: “The minutes of last month’s MPC meeting made it clear that the committee is split. The more hawkish members may see today’s data as evidence that their concerns about inflation persistence are well founded.

"The implications for the more dovish members are unclear. On the one hand, they indicated they were becoming less interested in backward-looking measures of inflation persistence and were adopting a more forward-looking approach.

"And that shift had occurred despite a string of overshoots for services inflation. But on the other hand, from a presentational point of view, they might feel that they need to wait for inflation to surprise on the downside before they move. A hawkish response from markets to today’s data might also encourage the MPC to wait.”

Read more: UK inflation unchanged at 2% in June

Although it remained at its lowest levels since 2021 and at the Bank of England’s target, inflation was higher than economists' estimates of a drop to 1.9%.

Anna Leach, chief economist at the Institute of Directors, said: "The Bank will be relieved that headline inflation has remained at target in June in line with their expectations.

"That relief will be tempered though by services inflation holding at 5.7%, well above their expectations. Stickiness in services inflation — a key measure of domestic inflationary pressures — lowers the likelihood of an August rate reduction."

Globally, inflation is showing signs of rising, with the Federal Reserve delaying its rate-cutting pathway and the European Central Bank increasing its inflation forecasts for the rest of the year.

The BoE forecasts inflation to be at 2.5% by the end of 2024, with price rises only returning to 2% sustainably in early 2026.

Sam North, analyst at investment platform eToro, said: “The BoE hawks take the victory. UK inflation held steady at 2% in June, slightly above expectations, driven by rising hotel and restaurant prices, while clothing prices fell. This persistent inflation reduces the likelihood of an August rate cut, with markets reacting cautiously. Further wage data on Thursday will be crucial in shaping future monetary policy decisions."

However, some economists are calling for a rate cut as inflation held steady at the BoE's target of 2%.

George Dibb, associate director for economic policy at IPPR, said: "Today’s data confirms that inflation is well on its way towards normalisation. Some inflation drivers, such as core inflation, are still elevated, but the Bank of England’s policy stance remains too tight. Interest rates have been too high for too long and need to come down to not hamper growth."

Another variable coming to the table at Threadneedle Street is the new UK government’s pledge to make the minimum wage a "genuine living wage". That follows a nearly 10% increase in April for the lower wage threshold.

Read more: What the new Labour government means for your money

The party has said it will implement its "new deal for working people" in full within the first 100 days.

“Labour’s pledge to introduce a ‘real living wage’ points to the possibility of stronger wage growth and some risk of slower rate cuts, but the magnitude of the change remains uncertain,” said James Moberly and Sven Jari Stehn, economists at Goldman Sachs.

The UK’s central bank warned in June that the national living wage hike in April “could have a bigger impact than expected”.

Some are certain there will be an interest rate cut, with a money markets trader placing a £2m bet on the BoE making the biggest interest rate cut in four years next month.

The trader would stand to net an £8m profit should policymakers reduce borrowing costs by half a percentage point from 5.25% to 4.75% in August, according to Bloomberg.

The last time the BoE cut interest rates by half a percentage point was in the days after Britain was plunged into the first Covid lockdown in March 2020, when it reduced borrowing costs from 0.75% to 0.25%.

The Bank of England will announce its interest rate decision on 1 August around noon, which will be accompanied by a quarterly monetary policy report where new forecasts will be unveiled. There will also be a press conference, where Bailey will speak for the first time since the general election.

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