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The Bank of England (BoE) has taken the significant step of lowering the UK base rate, from 5.25% to 5% on 1 August 2024. This follows nearly a year of holding the rate steady in an attempt to curtail rising inflation. The vote was close, with 5 out of 4 members of the Monetary Policy Committee (MPC) voting in favour of a cut.
With pressure building on other central banks – particularly on the Federal Reserve (Fed) in the US – what might happen next? Will the BoE follow with another “hawkish” cut below 5% in the coming months? What might all of this mean for investors?
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Why did the BoE cut rates?
Before the MPC vote on 1 August, markets were divided about whether the Bank would cut rates. This uncertainty was later reflected in the narrow vote in favour. The Governor of the Bank, Andrew Bailey, said that inflationary pressures had “eased enough” in the UK to justify taking the foot off the break slightly with interest rates.
For two successive months leading up to the 1 August vote, CPI (Consumer Price Index) inflation had been riding at the BoE target of 2%. With its criteria met, the BoE risked sending mixed signals to markets by not cutting the base rate.
Indeed, we are arguably now witnessing the results of central bank “over-caution” in the US. In the first week of August, global stocks plunged, and US unemployment rose, leading to fears of a recession. Some voices claimed that the Fed had not acted quickly enough to mitigate this by cutting rates.
Are further rates coming?
Domestic and international factors will play a key role in the coming months as the MPC deliberates further interest rate changes. At home, the Bank will be watching the underlying figures behind the UK price level – not just the headline rate of CPI inflation.
Of particular concern is the country’s persistent services inflation. The most recent figures in June 2024 show the rate still stubbornly high, at 5.7%. This follows two previous months with services inflation near 6%, even as CPI inflation has been falling.
The UK is a services-based economy, so the figures for services inflation is not insignificant. Much of the inflation figures is driven by persistent wage growth (most UK workers are employed in service sectors, not goods). There have been signs that wage growth may be slowing, which could embolden the BoE to cut interest rates further. However, this could be counteracted by the government’s decision on 8 August to increase pay for public sector workers (e.g. teachers and NHS nurses).
Further afield, the BoE will watch other central banks’ actions. The Federal Reserve, in particular, is highly influential due to the global dominance of the US economy. For instance, if the Fed makes interest rate cuts in the coming months (as many expect it to do), then this could have knock-on effects for the UK – e.g. the exchange rate between USD and GBP and “hot money” flows as international investors seek the best interest rates.
What does this all mean for investors?
Standard knowledge states that falling interest rates are generally good for borrowers and bad for savers. For instance, homeowners might enjoy greater access to lower mortgage rates, whilst those opening a Cash ISA could see lower interest rates compared to earlier in the year. In reality, UK banks are usually faster to pass down a cut to their customers with savings than those with mortgages.
In August 2024, savers should probably not be accepting a cash interest rate below 5%. However, if the BoE cuts its base rate later in the year, it is reasonable to expect savings rates to become less attractive. For investors, changes in interest rates will likely have a big impact on your options in the wider market. They could also affect the current holdings in your portfolio. So, make sure you have a plan.
A fall in interest rates could boost UK economic growth further. Consumers find it easier to access cheaper finance for “big ticket” items (e.g. furniture paid on finance), which can boost aggregate demand and wider confidence in the economy. Lower rates could put more money in homeowners’ pockets if their mortgage payments fall. Startups may be able to gain cheaper business loans. Investors may be tempted away from fixed-income securities like UK government bonds as coupons reduce, making equities more attractive.
However, it seems unrealistic to expect a return to the “old days” of interest rates near 0%, as seen before December 2021.
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