Interest rate cut hopes fade after Bank of England decision
City investors have lowered expectations of multiple interest rate cuts later in the year after the Bank of England decided to reduce rates to 4.25 per cent.
Prior to the Bank’s decision on Thursday at 12.02 pm, markets priced in around three more cuts this year in predictions that would take interest rates to 3.5 per cent.
But the Monetary Policy Committee’s “hawkish” views have made investors think twice about what could happen over the rest of this year.
Traders were now pricing in two more cuts this year, with a third cut to borrowing costs standing at a chance of around 40 per cent.
The possibility of three more interest rate cuts following the May decision previously stood at roughly 80 per cent.
It is possible that markets were spooked by the divide seen within the MPC as a 5-4 decision in favour of a 25 basis point cut exposed some of differences in opinion among rate-setters.
External members Swati Dhingra and Alan Taylor voted for 50 basis point cuts while chief economist Huw Pill and Catherine Mann, who voted for a radical interest rate cut in February, voted for a hold to rates.
Interest rates divide
Deutsche Bank’s Sanjay Raja described the split as reflective of a “more divided MPC”.
“For all the hype, the MPC basically took a step back to where they were a month or two ago,” Deutsche Bank’s Sanjay Raja said.
“The probability of sequential back-to-back rate cuts should drop on the back of this.”
Goldman Sachs economist Sven Jari Stehn and James Moberly were among analysts left stunned by the Bank’s decision to stick to its “gradual and careful” approach to rate-cutting as they said the minutes were “more hawkish” than expected.
They highlighted sections from the minutes showing how members who voted for a rate cut had done so for different reasons.
“The minutes noted that ‘most’ of the five members who voted for a 25 basis point cut had, before the latest global news [on a UK-US trade deal], viewed the May decision as ‘finely balanced’ between no change and a cut,” they said.
“That said, the minutes did indicate that for other members in that group the case for a cut had been ‘fairly clear’ even before the latest global developments.
“Those who voted for a hold noted the decline in short-end market interest rates since the March meeting. The two members who voted for a larger cut argued that a continued policy stance that was ‘too restrictive’ risked opening up ‘an unduly large output gap’ and inflation deviating from target on a sustained basis.”
The minutes to the meeting said the risks of President Trump’s tariffs were double-sided but they were set to have more of a “disinflationary” effect.
Capital Economics’ Ruth Gregory suggested Bank Rate will only go as far down as 3.75 per cent by the end of the year.
“The MPC implied it is less inclined to slow the pace of rate cuts than it was in March, but it did not send a strong signal that it will speed up,” Gregory said.
“What’s clear is that market expectations of three rate cuts, taking Bank Rate to 3.5 per cent by the end of this year, is a step too far, although rates may get there or below eventually.”