The Bank of England risks becoming public enemy number one again this week. On Thursday, the Bank’s Monetary Policy Committee will announce its final decision on interest rates. If he surprises markets by cutting rates just two weeks before election day, some will accuse him of trying to do favors for the Conservatives.
On the other hand, if it waits, despite good news on inflation and bad news on growth, others will conclude that the Bank is biased against Labour. Either accusation would be grossly unfair. So how will the MPC find its way through this political minefield?
As a starting point, the MPC never changed interest rates at the meeting just before the general election. However, since the Bank was given the independence to set interest rates in May 1997, there have been only six general elections and no changes to interest rates for most of this period.
There is absolutely no rule against individual MPC members voting to change rates during the election campaign. Sushil Wadhwani voted for a rate hike in June 2001 and Sir Andrew Large did the same in April 2005. Perhaps the most interesting example is November 2019, when two members who had previously voted for no change moved to cut rates; Jonathan Haskel (still voting). at MPC) and Michael Saunders.
We can safely conclude that the two current members who have already voted for the cut (Swati Dhingra and Dave Ramsden) will do the same this week. The question then is whether three or more of the remaining seven members are ready to join them, forming a 5-4 majority to lower rates.
There are some good reasons why the Bank of England might be right to wait a little longer.
UK inflation has been relatively stubborn, particularly inflation in the “core” measure (excluding food and energy) and services sector inflation. Forward-looking research on business activity and consumer confidence is encouraging, and broad currency and credit holdings appear to be healthier.
It is therefore perfectly reasonable (and desirable) for the MPC to have a diversity of views here. Some prominent former members, including the bank’s former chief economist Andy Haldane, had been calling for a rate cut for months. But others, including Andrew Sentance, argued for caution. These experts are neither stupid nor deceitful.
Regardless, my view is that the new information received last week strengthens the possibility of a rate cut on Thursday. The economy could not grow at all in April. Hopefully activity was only reduced by the wet weather, but this was a bad start to the second quarter.
The labor market also continues to cool; Unemployment is rising and early evidence from May suggests wage pressures are now easing after a rebound in April.
Meanwhile, the results of the Bank’s own surveys should reassure those still worried about the “wage-price spiral”.
Earlier this month, the Bank’s Decision Making Panel reported that businesses’ wage growth expectations for next year fell to 4.1 percent in May from 4.6 percent in April.
We can now add the Bank’s quarterly survey of the public’s inflation expectations for the next 12 months. The average estimate fell to 2.8 percent from 3 percent in February. This is well below the peak of 4.9 per cent in August 2022 and returns to the 2000-21 average.
The determining factor may be May inflation data. This will be made public on Wednesday morning, the day the MPC will make its decision.
The headline gauge fell slightly less than expected to 2.3 percent in April, prompting markets to pull back expectations on the timing of the first rate cut.
Indeed, all but two of 65 economists surveyed recently by Reuters expected the Bank to wait until August, with the two outliers expected to hold for September.
But there’s a good chance May’s figures will show inflation finally returning to its 2 percent target, or even lower. This will of course make it much easier for the Bank to cut interest rates this week, especially if essential and services measures are also sharply lower.
So the balance may still tip in favor of an early cut. This wouldn’t be too risky. A quarter-point cut would leave UK interest rates at 5 per cent, just above the “neutral” level. This, combined with the bank’s relatively aggressive sales of government bonds (the controversial policy known as quantitative tightening), will continue to suppress inflation.
Moreover, the Bank’s own forecasts predict that inflation will fall to the 2 percent target and remain at the same level over the next few years, even based on market expectations of a series of interest rate cuts.
Improvements in business and consumer confidence are also based on hopes that low inflation will allow interest rates to be reduced. The recovery could still be stalled if the Bank of England doesn’t deliver soon.
Consistent with this, the latest survey by the Royal Institution of Chartered Surveyors found that the recovery in the UK housing market is beginning to weaken again as expectations for interest rate cuts fade.
These factors should trump any concerns about political outlook. But in any case, the latest polls hardly suggest that this is a cliff-edge election where the latest interest rate decision could swing the outcome either way.
If there is enough new information to justify lowering interest rates and it will not completely blunt the markets, then that is what the MPC should do. Fingers crossed for a pleasant surprise.
Julian Jessop (@julianhjessop) is an independent economist. Jeremy Warner away