Is the Old Lady of Threadneedle Street ready to fight the markets?
21 Jun, 2024


Azad Zangana, Senior European Economist & Strategist at Schroders


Slowing UK growth and encouraging inflation trends make a strong case for the Bank of England (BoE) to cut interest rates today (20 June). Inflation has fallen to its lowest level in almost three years. Meanwhile, growth stagnated in April, as the unemployment rate (three-month rate) rose to 4.4%, with the economy shedding 140,000 jobs.


So, will the BoE cut? The implied probability from the options market suggests only a 6% chance, so clearly the thinking is no cut. Indeed, there is just a 30% probability priced that the BoE will cut even by the August meeting of the Monetary Policy Committee (MPC).


The reason for this caution is principally on concerns among investors (as reflected in money markets) that the fall in UK inflation back to BoE’s central inflation target of 2% in May will only prove temporary. And the money markets have historically dictated timing of central bank policy in the UK.


I’m not surprised that of the 65 economists polled by Reuters, not one is predicting a cut today, nor are we (we’re forecasting a cut in August).


Precedent has BoE falling into line with the market


Despite the case for a rate cut being strong, the thinking amongst the investor community is that the BoE will only ease once the market is ready. You see, the Old Lady of Threadneedle Street doesn’t have the same tough reputation as its American counterpart.


The phrase coined in the 1970s “Don’t fight the Fed” was originally directed at equity investors, but the old mantra has since served to warn investors at large not to bet against the Federal Reserve’s policy makers.


Should the BoE follow through on its dovish signals (see below) and fight the market? Well, yes and no. A surprise rate cut would move markets, and in particular weaken the pound against other major currencies.


This is not necessarily a problem, as it would boost the competitiveness of UK exporters. However, it would also raise the cost of imported goods, contributing to higher inflation in the near-term.


Instead, the MPC should, if it feels it’s appropriate to do so, provide the strongest possible signal yet that easing is imminent. It should do this in the hope that more investors believe and bet that the Bank will cut in August. This would ease financial conditions to some degree straight away and would make the cut easier for the currency market to digest when it follows in August.


The alternative would be to follow markets, and struggle to explain to the public why the bank has not eased, despite data generally going in the right direction. With the UK general election looming, unwelcomed allegations of political favouritism could follow if the communication is not spot on.


Bank’s shift to a dovish stance


In recent meetings the MPC has slowly shifted towards a more dovish stance. The last meeting in May strongly hinted at the imminent start of a cutting cycle, raising hopes of some relief for households.


However, since that meeting, money markets have moved to push out the timing of the first interest rate cut despite recent weaker data in the UK. Some of the delay in the pricing for the first cut can be attributed to international markets (mainly the US). Concerns remain, however, that the fall in UK inflation may only be temporary, and high wage inflation is driving the elevated rate of inflation in services, which was 5.7% in May.


The BoE has in recent months flagged that inflation is likely to rise in the near-term as it takes longer for domestic inflation pressures to dissipate. However, in its previous projections, it saw inflation undershooting target in the medium term, as implied by a lower interest rate profile than is currently priced by markets.




@Azad Zangana, Schroders
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