- Heightened conflict in the Middle East adds to the mixed messages on inflation
- The chancellor could do with some interest rate cuts ahead of what looks like being a tight autumn Budget
- CPI is still way above target, and the public have already been bitten by the idea of transitory inflation
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“Interest rate decisions don’t seem to be getting any easier. The escalation of conflict in the Middle East has bumped up the oil price, which will put upward pressure on inflation if sustained. Meanwhile the threat posed to the global economy from tariffs remains present, if not quite as enormous as it did two months ago. Then there’s the UK economy, which contracted sharply in April, albeit after a good growth spurt in the first quarter of the year. Add in a weakening labour market, and you have a smorgasbord of mixed messages which the Bank of England has to make some sense of.
“Little wonder that at the last meeting of the MPC, the committee was split in terms of the direction of monetary policy. Markets are currently pricing in only a 10% chance of a rate cut, with the consensus landing on a rate cut in August or September, and then another one by year end. The chancellor would dearly love to see rate cuts sooner rather than later. The longer the Bank of England sits on its hands, the higher the cost of government debt in the OBR’s forecasts, and the more diminutive the fiscal headroom for Rachel Reeves in what already promises to be a tight Budget this autumn.
“It's going to be very hard for the Bank to cut interest rates when CPI is so far above target, with further potentially inflationary pressures coming from higher energy prices and the chancellor’s national insurance hike. Employers might seek to defray the cost of higher rates of national insurance through less hiring and lower pay awards, but some of it will inevitably feed through into prices. The headline CPI figure now stands at 3.4%. This of course tells us what happened over the last 12 months, while the Bank analyses inflation looking forward over three years.
"Nonetheless, the Bank of England would have a lot of explaining to do if it were to cut interest rates with inflation more than 1% above target. The public have already been bitten once by the idea of transitory inflation, so the Bank will be naturally shy to peddle this narrative again. Those due to be remortgaging in the next year or so would no doubt find some relief in looser monetary policy. But anyone who has locked into higher fixed mortgage rates already, along with the small army of savers who have been hoarding cash like it’s going out of fashion, would be somewhat miffed if the Bank decided it’s now time to take their foot off the brake.”
