The market appears to be pricing in a 50-50 chance that the BOE Rate Decision will cut rates when its policy meeting ends tomorrow. That means the market is likely to react no matter what happens. But there are some indications that a cut is actually more likely than what market participants think.
Generally, central banks like to give plenty of advance warning about changes in monetary policy so the market has a chance to adjust in advance. This is particularly the case for the Bank of England, because of what happened following the disastrous “minibudget” of 2022. That’s when a shift in interest rates over concerns surrounding Britain’s capacity to make debt payments set off a chain-reaction that forced the BOE to step in and stabilize the market. So, there is good reason to not surprise the markets with changes in the interest rate for now.
Filling the Growing Hole
The thing is, the last time that the BOE met, it largely punted on policy in order to keep to the sidelines around the general election. Which means it hasn’t had the opportunity to clearly foreshadow easing at the current meeting. On the other hand, Governor Andrew Bailey has said a few times that the market is doing a good job of predicting that there will be rate cuts. This could mean that the central bank feels it has done enough to prepare the markets for a move.
Meanwhile, the new government is shaking things up a little bit. The new Chancellor, Rachel Reeves, recently said that there is a shortfall in the country’s funds, implying that new taxes will be needed. This is contrary to the pre-election messaging that policy would remain largely unchanged, though it is hardly a surprise. The market expected higher spending and taxation, except in that order. The messaging suggests that Downing Street is looking to raise taxes before increasing spending, which would put pressure on the slow rebound the country is experiencing. Slower economic growth without an increase in spending would likely incline the BOE towards cutting.
The Signs of Easing
Ahead of the BOE meeting, there were two major signals that the time has finally come for a cut. First was a survey of economists, which showed that around 80% expect easing to start with the August meeting. Economists are likely reading from the same playbook as the BOE’s MPC members. Then early this morning, the Shadow MPC voted to suggest that easing was the right course for the BOE as well.
Although the economy is still growing strong, and recent jobs numbers show that wages are growing in reflection of a tight market, inflation coming back to target is taking precedence. And economists also suggest that the economic rebound is likely to slow a bit, rather than accelerate – unless the BOE brings rates down to support borrowing.
It Will be Tight, Nevertheless
The consensus is that regardless of what will happen, the vote will be close, with a 5-4 split. Markets could get a shock if the vote is more unbalanced, suggesting a stronger preference either for holding or cutting than is currently anticipated. The other factor is that the BOE could split the difference. That could be by holding rates steady but heavily implying a cut in September; or cutting and heavily implying that rates will be held for a while to see what happens.
The scenario is set up for quite a bit of volatility in cable and other sterling pairs, particularly if the market ends up waiting for Bailey’s post-rate decision to make up its mind. With a narrow vote split, the markets could rely more on subjective interpretation of commentary, leading to more uncertainty.
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