Pivotal Base Rate Decision Approaches
The next round of inflation and employment stats are due this week, two data releases that can have a big effect on what may be a pivotal base rate decision on 7 August which will reveal how the Bank of England views the balance between taming inflation and supporting a slowing economy.
Max Shepherd, Group Economist at Yorkshire Building Society, offers an insight into how the Bank of England Monetary Policy Committee (MPC) may be thinking in issue 16 of INTEREST by Moneyfacts.
To help illustrate possible future interest rate paths, the Bank of England has laid out three possible economic scenarios, which remain broadly relevant today and give some idea on where rates may travel.
They were set in the context of the rapid rise in inflation over recent years, all with different interest rate implications.
- Inflation experienced in recent years was transitory and will subside quickly without leading to further wage and price pressures. Interest rates can therefore be reduced cautiously as inflation unwinds.
- A period of economic slowdown in which growth slows and unemployment increases might be required in order for wage pressures and inflation to reset. Interest rates need to remain higher for a period, rates can fall once inflation stabilises and the economy slows down.
- The economy has experienced a structural shift in wage and price setting following the major supply shocks that we have experienced over recent years. The current level of interest rates therefore is less restrictive than expected, meaning that monetary policy will have to remain tighter for longer.
The Bank of England Monetary Policy Committee (MPC), comprising nine members, five of whom work at the bank (including the Governor, Andrew Bailey), and four external members appointed by the Chancellor of the Exchequer, has a primary mandate to keep inflation low and stable, with a target of 2%. The main tool to control this is the base rate, currently set at 4.25%.
The challenge is predicting how the majority of MPC members will vote in future meetings, considering recent economic developments, speeches from members and voting history. As mortgage pricing is based on an average of where base rate is today and where it will be at the end of the product, (for example, a five-year fixed rate mortgage will be priced relative to the perceived average base rate over a five-year period) mortgage rate setters need to predict not only the voting in the upcoming meeting but voting across all future meetings.
This explains why interest rates and specifically mortgage rates have been so volatile in recent years.
Each MPC member has individual views and differing opinions on which scenario most reflects the current situation. They cast their vote and a simple majority applies. If there is a tie, the Governor gets the casting vote.
The market tends to categorise these members into two categories, or somewhere in between – ‘doves’ and ‘hawks’.
Both dovish and hawkish policy can be argued as the right approach, especially with low growth and above target inflation, and members’ views are constantly evolving, so predicting how they will vote at each meeting is not straightforward.
Given Bailey has implied quarterly rate cuts in the current environment, two more cuts this year is a sensible bet and probably aligns with the majority of MPC members’ thinking, one in August and one in November (in line with the publication of the Bank’s quarterly economic forecasts).
That said, there are risks to both sides of this projection. If inflation proves more persistent and wage growth is sustained, we could see the Bank of England pause its cuts and wait for signs of inflation subsiding.
However, if unemployment increases faster than expected, and growth proves sluggish or even negative, we may see an acceleration of interest rate cuts. (Read more on pages 8 & 9)
Adam French, Consumer Expert at Moneyfacts, said: “After gradually reducing rates from their peak over the past year, the Bank of England stands at a pivotal moment as it seeks to balance persistent above target inflation with stalling economic growth and a jobs market that is believed to be weakening.
“The upcoming base rate decision will be more than a number and it will provide critical insight into how the Bank of England views the balance between taming inflation and supporting a slowing economy. Beyond the immediate market reaction, it will shape mortgage rates, guide fiscal confidence and underpin the central bank’s institutional credibility.”
Read more in the latest issue of the INTEREST journal, which you can read for free here. Part or all of this press release can be reproduced, so long as we are sufficiently sourced.
Pivotal Base Rate Decision Approaches
The next round of inflation and employment stats are due this week, two data releases that can have a big effect on what may be a pivotal base rate decision on 7 August which will reveal how the Bank of England views the balance between taming inflation and supporting a slowing economy.
Max Shepherd, Group Economist at Yorkshire Building Society, offers an insight into how the Bank of England Monetary Policy Committee (MPC) may be thinking in issue 16 of INTEREST by Moneyfacts.
To help illustrate possible future interest rate paths, the Bank of England has laid out three possible economic scenarios, which remain broadly relevant today and give some idea on where rates may travel.
They were set in the context of the rapid rise in inflation over recent years, all with different interest rate implications.
- Inflation experienced in recent years was transitory and will subside quickly without leading to further wage and price pressures. Interest rates can therefore be reduced cautiously as inflation unwinds.
- A period of economic slowdown in which growth slows and unemployment increases might be required in order for wage pressures and inflation to reset. Interest rates need to remain higher for a period, rates can fall once inflation stabilises and the economy slows down.
- The economy has experienced a structural shift in wage and price setting following the major supply shocks that we have experienced over recent years. The current level of interest rates therefore is less restrictive than expected, meaning that monetary policy will have to remain tighter for longer.
The Bank of England Monetary Policy Committee (MPC), comprising nine members, five of whom work at the bank (including the Governor, Andrew Bailey), and four external members appointed by the Chancellor of the Exchequer, has a primary mandate to keep inflation low and stable, with a target of 2%. The main tool to control this is the base rate, currently set at 4.25%.
The challenge is predicting how the majority of MPC members will vote in future meetings, considering recent economic developments, speeches from members and voting history. As mortgage pricing is based on an average of where base rate is today and where it will be at the end of the product, (for example, a five-year fixed rate mortgage will be priced relative to the perceived average base rate over a five-year period) mortgage rate setters need to predict not only the voting in the upcoming meeting but voting across all future meetings.
This explains why interest rates and specifically mortgage rates have been so volatile in recent years.
Each MPC member has individual views and differing opinions on which scenario most reflects the current situation. They cast their vote and a simple majority applies. If there is a tie, the Governor gets the casting vote.
The market tends to categorise these members into two categories, or somewhere in between – ‘doves’ and ‘hawks’.
Both dovish and hawkish policy can be argued as the right approach, especially with low growth and above target inflation, and members’ views are constantly evolving, so predicting how they will vote at each meeting is not straightforward.
Given Bailey has implied quarterly rate cuts in the current environment, two more cuts this year is a sensible bet and probably aligns with the majority of MPC members’ thinking, one in August and one in November (in line with the publication of the Bank’s quarterly economic forecasts).
That said, there are risks to both sides of this projection. If inflation proves more persistent and wage growth is sustained, we could see the Bank of England pause its cuts and wait for signs of inflation subsiding.
However, if unemployment increases faster than expected, and growth proves sluggish or even negative, we may see an acceleration of interest rate cuts. (Read more on pages 8 & 9)
Adam French, Consumer Expert at Moneyfacts, said: “After gradually reducing rates from their peak over the past year, the Bank of England stands at a pivotal moment as it seeks to balance persistent above target inflation with stalling economic growth and a jobs market that is believed to be weakening.
“The upcoming base rate decision will be more than a number and it will provide critical insight into how the Bank of England views the balance between taming inflation and supporting a slowing economy. Beyond the immediate market reaction, it will shape mortgage rates, guide fiscal confidence and underpin the central bank’s institutional credibility.”
Read more in the latest issue of the INTEREST journal, which you can read for free here. Part or all of this press release can be reproduced, so long as we are sufficiently sourced.
