BoE holds rates but signals cautious approach to inflation

The Bank of England’s Monetary Policy Committee (MPC) voted 8-1 to maintain the Bank Rate at 5% in its September meeting, underscoring the central bank’s commitment to a restrictive monetary policy stance despite signs of easing inflationary pressures.

Inflation Outlook and Economic Growth

While headline inflation has retreated significantly from its peak, the Bank remains vigilant about persistent inflationary pressures, particularly in the services sector. As stated in the minutes, “Services consumer price inflation remained elevated at 5.6% in August.” This persistence in services inflation is a key concern for policymakers, reflecting ongoing wage pressures and potential structural shifts in the economy.

The MPC expects CPI inflation to “increase to around 2½% towards the end of this year as declines in energy prices last year fall out of the annual comparison.” This projection suggests that the battle against inflation is far from over, despite the recent moderation in headline figures.

Economic growth, while modest, has shown resilience. The Bank’s staff now expect “GDP growth of 0.3% in 2024 Q3, marginally weaker than the 0.4% rate that had been incorporated in the August Report.” This slight downward revision reflects the complex balance the MPC must strike between controlling inflation and supporting economic activity.

Labour Market and Wage Growth

The labour market continues to show signs of gradual easing, although it remains tight by historical standards. The MPC noted that “Private sector regular average weekly earnings growth had declined to 4.9% in the three months to July.” This moderation in wage growth is a positive sign for inflation control, but the pace of decline remains slower than the MPC might prefer.

The Bank’s Agents report provides additional colour on wage pressures: “The latest Agents’ intelligence indicated that pay settlements over the second half of the year were, as expected, coming in at lower rates compared to H1, and 2025-expected settlements might be in a 2 to 4% range.” This forward-looking insight suggests a potential further easing of wage pressures, which could help bring services inflation down over time.

The MPC’s decision to hold rates steady reflects a careful balancing act. As stated in the minutes, “Monetary policy would need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term had dissipated further.”

However, the Committee also signaled a potentially more gradual approach to future policy changes. The minutes noted, “For most members, in the absence of material developments, a gradual approach to removing policy restraint would be warranted.” This suggests that while the MPC remains committed to its inflation target, it is mindful of the lagged effects of past rate hikes and the potential risks to economic growth from an overly tight policy stance.

The lone dissenting voice on the Committee voted for a 0.25 percentage point reduction in Bank Rate, arguing that “Bank Rate needed to become less restrictive now to enable a smooth and gradual transition in the policy stance, and to account for lags in transmission.” This dissent highlights the difficult trade-offs facing policymakers in the current economic environment.

Quantitative Tightening

In addition to its interest rate decision, the MPC unanimously voted to reduce the stock of UK government bond purchases by £100 billion over the next 12 months. This continuation of quantitative tightening is expected to have a modest tightening effect on yields, though the precise impact is difficult to measure.

Implications for Businesses and Financial Markets

The Bank’s decision and forward guidance have significant implications for UK businesses and financial markets. The continued high level of Bank Rate suggests that borrowing costs will remain elevated in the near term, potentially impacting investment decisions and corporate finance strategies.

For financial markets, the MPC’s signal of a potentially more gradual approach to future policy changes could lead to a reassessment of interest rate expectations. As noted in the minutes, “Market-implied paths for policy rates across economies had generally ended the period lower,” reflecting a broader trend of easing rate expectations globally.

The Decision Maker Panel (DMP) survey provides insight into business expectations, noting that “firms expect year-ahead wage growth to be 4.1% in the three months to August.” This suggests that businesses are anticipating continued wage pressures, albeit at a moderating pace, which could impact profit margins and pricing strategies.