Which scenario will BoE meeting follow?

The Bank of England faces a critical decision on interest rates as policymakers weigh whether to reduce borrowing costs for the first time since the onset of the Covid-19 pandemic.

Following a significant decline in inflation this year, Threadneedle Street is poised for its first rate cut since raising interest rates from a historic low of 0.1% in December 2021 to the current level of 5.25%. Financial markets anticipate a quarter-point reduction to 5% during Thursday’s meeting, although the outcome remains uncertain. Some economists suggest the central bank might delay the decision until its next policy meeting in September.

Official data from June indicates that headline inflation remained at the 2% target for a second consecutive month, having dropped from a peak of 11.1% in October 2022 during the cost of living crisis triggered by the Russian invasion of Ukraine and subsequent energy price surge.

The Bank’s decision hinges on whether service sector price growth is slowing and if the UK job market is cooling to levels consistent with maintaining inflation near the government’s 2% target. While wage growth slowed in May and unemployment remained stable, stubborn pressures persist in the domestic economy. Notably, the UK experienced a stronger-than-expected recovery from recession in the first quarter of the year.

Within the Bank’s nine-member monetary policy committee, three members have expressed concern about persistent inflationary pressures. Chief economist Huw Pill considers the timing of a rate cut an open question. Meanwhile, Swati Dhingra, a consistently dovish MPC member, advocates for easing interest rates to alleviate living standards.

Financial markets have been volatile, reflecting the challenge of predicting the outcome. City economists expect a close vote, with five in favor of a cut and four against, while Governor Andrew Bailey holds the decisive vote. As of Wednesday evening, financial markets priced in a 65% probability of a rate cut.

Financial markets are closely watching the Bank of England (BoE) as it prepares for its upcoming meeting. Here are the key scenarios and their potential implications:

Rate Cut Expectations:

The prevailing expectation is a 25 basis point rate cut by the BoE. If this materializes, it could push 10-year yields below 4%, impacting bond markets. For GBP/USD, this presents a clear downside risk.

Decision Dynamics:

The BoE meeting is currently a 50:50 call between a rate cut and a ‘hold’ decision. While leaning towards a cut, uncertainty remains. Committee members, who found the June decision “finely balanced,” hold the key.
Recent upside news on services inflation complicates the interpretation. Governor Andrew Bailey’s previous statement suggests an eagerness to cut rates.

Vote Split and Forward Guidance:

We expect a 6-3 vote in favor of a rate cut this Thursday.
External members may be reluctant, but historical patterns suggest group movement. Forward guidance will likely be vague, typical of the BoE. Even if rates are cut, timing and scope won’t be explicitly committed.
The dovish risk scenario involves Governor Bailey hinting more directly about future steps.

Market Impact:

Sterling markets are uncertain compared to US and Eurozone pricing. A BoE rate cut could significantly affect rates. The 10Y Gilt yield, which hasn’t broken 4.0% since March, may head lower. The pound faces headwinds due to the easing cycle and Brexit-related factors. Expect GBP/USD downside risk.