Although the Bank was cautious today, it could speed up its interest rate cuts next year if it grows more confident that inflationary pressures are easing.

ING developed markets economist, James Smith, predict that this will allow the Bank to lower rates to 3.25% by next summer, from 5% today. That would be the lowest since November 2022.

Smith says:

“The Bank’s hawks worry that corporate price and wage-setting behaviour has permanently shifted in a way that’s going to make it perpetually harder to get inflation down on a sustained basis. We’re not convinced that’s the consensus view on the committee right now – August’s decision to cut rates certainly suggests it isn’t. But so long as wage growth and services inflation remain sticky, then the committee as a whole seems happy to tread carefully. We’re less convinced that the UK’s easing cycle will deviate that much from the Fed or others. As the Bank readily concedes, the recent stickiness in service sector inflation is mostly down to volatile categories that hold little relevance for monetary policy decisions. Strip that out, and the picture is slowly looking better.

“Meanwhile, the jobs data, though admittedly of dubious quality right now, points to an ongoing cooldown too. The number of payrolled employees appears to be falling now and that will inevitably feed through to wage growth. Companies are consistently lowering their estimates of expected and realised price/wage growth, according to a monthly BoE survey.

We therefore think that Bank of England rate cuts will accelerate after November. Beyond then, we think the Bank will grow more confident in the persistence of inflation and there will be sufficient consensus on the committee to switch to back-to-back rate cuts. Like investors, we expect a cut in November and December, with further cuts in 2025 taking us to 3.25% by the end of next summer.”

Analysis: Why did the Bank of England not cut interest rates?

Phillip Inman

At 5%, UK interest rates now ranks as the highest among major economies, my colleague Phillip Inman points out.

But the economy is far from overheating, he writes:

Economic growth remains stagnant and employment is well down from its pre-pandemic level. Businesses are not investing and consumer confidence, which rose earlier in the year, has stalled.

According to these measures, interest rates should be on the way down and at a much faster pace.

The MPC, or at least most of its nine members, says this analysis ignores important dynamics in the post-pandemic economy that are inflationary. It believes the jobs market remains stuck in a groove of ever higher wages that have yet to be choked off by high interest rates.

While the employment rate is down, this has not translated into unemployment going up by much. Instead, workers have bailed out of the labour market altogether. Some have joined the ranks of the long-term unemployed. These are working-age people who, in a previous era, were able to retrain and find a new job. Others have been signed off sick. Others have taken early retirement.

Without a thriving jobs market and a confident business sector keen to invest, the Bank judges growth will remain low and the economy unable to expand by much next year and the year after without being inflationary.

As well as leaving interest rates on hold today, the Bank of England also decided to maintain the size of its bond-selling programme, called quantitative tightening (QT).

Under QT, the Bank is selling UK government debt bought after the financial crisis and the pandemic, to reduce the size of its balance sheet to more normal levels.

It has decided to maintain the pace of QT at £100bn over the next 12 months, despite speculation that it might either speed up, or slow down, the process.

Most of the £100bn – £87bn – will be covered by maturing bonds, so there will only be 13bn of ‘active sales’ over the next year.

Thomas Pugh, economist at audit, tax and consulting firm RSM UK, explains:

“The MPC decided to keep its quantitative tightening envelope at £100bn over the next year. That is important for the Chancellor and the Autumn Budget as it implies just £13bn of active sales against an OBR forecast of £48bn.

The difference will shave some £2bn from her already wafer-thin headroom against the current fiscal target and makes it even more likely that she will opt to change the definition of debt used in the fiscal rule. Using Public Sector Net Debt (PSND) instead of the current metric that excludes the BOE (PSNDex), could also free up around £16bn based on the March OBR numbers.

Suren Thiru, economics director at Chartered Accountants’ group ICAEW, fears the Bank of England will be “painfully cautious” with rate cuts in coming months, having left interest rates on hold today.

“Keeping interest rates unchanged will be a notable setback to households contending with burdensome mortgage bills and businesses grappling with a variety of other cost pressures.

“While this decision doesn’t mean the end of the rate-cutting cycle, it does suggest that the pace of policy loosening is likely to be painfully cautious, with rate setters still concerned that underlying inflation remains too high.

“Although only one rate-setter voted to loosen policy, the relatively dovish tone of the minutes suggest that the Monetary Policy Committee is shifting towards cutting interest rates when it next meets in November.

“Continuing to keep interest rates elevated risks hampering the government’s ambition of significantly higher annual GDP growth by keeping borrowing costs too high for too long, limiting investment and growth opportunities for businesses.”

James Sproule, UK chief economist at Handelsbanken says yesterday’s inflation report was “undoubtedly key” to today’s decision.

While the August inflation rate overall held steady at 2.3%, services inflation rose from 5.7% to 5.9%, largely driven by earnings. Longer term the outlook is that the overall 2% inflation target can be sustainably maintained so long as goods inflation is around -1%, while services inflation sits at around 3%.

For the moment goods inflation is negative at -0.9%, although longer term as and when supply chains are rebalanced away from China, maintaining that negative price trend may prove a challenge. As to services inflation and earnings, there is an ongoing concern that above inflation (and well above productivity growth) pay rises being agreed by the new Government for a range of public sector workers could spill over into pay expectations in the private sector. Such an outcome would undoubtedly prompt the MPC to slow, or stop, its path of interest rate reductions.

Janet Mui, head of market analysis at wealth manager RBC Brewin Dolphin, says the Bank. has a “trickier” inflation challenge than its counterparts in the US and the eurozone:

After the Federal Reserve cut rates by 0.5% yesterday and the ECB cut rates a second time this month, the contrast is stark as the BoE holds. Arguably the UK sees a trickier inflation environment, as services inflation and wage growth remain above 5% YoY. Near-term economic momentum has improved in the UK, whereas in the US it has slowed.

Broadly speaking, as the factors driving inflation higher have been normalising, inflation is still expected to slow toward 2%. So, it is fair to expect that the BoE will be able to keep cutting rates over the course of the next 12-18 months, but at a gradual and modest pace. The next cut is largely expected to be November, needless to say, the BoE will remain data dependent.”

Alpesh Paleja, interim deputy chief economist at the CBI, says the Bank is walking a ‘fine line’:

“The Monetary Policy Committee was widely expected to hold fire this month, after the first rate cut in four years in August. There remain very varied views among the MPC around the degree of inflation persistence, and over what horizon this will dissipate.

Monetary policy will be walking a fine line for a little while yet: between balancing upside risks to inflation, but not being too tight, so as to choke off activity. Developments in fiscal policy in October’s Budget will also be a key consideration for growth prospects.

We still anticipate another rate cut in November, and a few more next year, in line with the MPC moving at a slow but steady pace. On their own, lower interest rates will be a welcome respite to households and businesses.”

The Bank of England’s reluctance to cut interest rates today is a blow to borrowers, such as mortgage-holders and credit card customers. Savers, though, will benefit.

Alice Haine, personal finance analyst at online investment platform Bestinvest by Evelyn Partners, says keeping interest rates on pause at 5% may be unsettling for households, particularly with a painful budget looming.

Haine writes:

“Many households, who have seen their finances battered by high living and borrowing costs over the past few years, are likely to have pinned their hopes on another rate cut, particularly those still contending with high mortgage and debt repayments. While the 25 basis-point cut on August 1 will have slightly eased the strain for borrowers – another cut would have cemented that sense of relief.

“The worst of the cost-of-living crisis may now be behind us, but the rapid price rises of the past few years are now baked in, so making ends meet remains a struggle for some. While food inflation is continuing to ease, rents, airfares and transport costs rose in August – indicating that the inflation pain of the past few years is not over just yet.

“With high living and borrowing costs over a sustained period leaving consumer finances under strain, some households have been forced to delay major purchases, such as a first or bigger home. Others have relied on credit to make ends meet, putting them at the mercy of the high interest charges on that debt.

But those with money in savings accounts will benefit, for the moment anyway, says Mark Hicks, head of active savings at Hargreaves Lansdown:

“The decision to hold interest rates steady at 5% is good news for savers. Banks and building societies had started to price in the possibility of a cut over the past few days, and if this had materialised, we would have seen others swiftly follow suit.

However, this good news is unlikely to last. Further cuts later this year are likely to hit the easy access market the most, because those rates remain the most sensitive to the base rate. Fixed rates are still the best option for anyone who doesn’t need the money close at hand. They offer similar rates to the easy access market, and mean savers can lock in these rates for the entire fixed period. As the downward trend in global interest rates is well under way, it will now become a question of how far rates will fall – and at the moment, the end isn’t in sight anytime soon.”

The odds of a cut to UK interest rates in November have fallen, following the cautious comments from BoE governor Andrew Bailey.

The money markets now indicates that a November rate cut is only a 60% chance.

Before noon, it was fully priced in, so that’s quite a change.

Why? Two factors, I think.

Firstly, the fact the MPC split 8-1 to leave interests rates on hold, while economists had expected a 7-2 split.

Second, Bailey’s comments about being careful “not to cut too fast or by too much”.