BoE will not cut rates too much or too quickly

Despite headline inflation running at the BoE’s 2% target in May and June (Exhibit 2), prices are expected to accelerate by 2.75% later in the year and fall back to a rate of 1.7% after two years and 1.5% after three years. The BoE outlined in the Monetary Policy Report that prices of some items are still rising quickly. Prices of services – for example hotels and restaurants, insurance, and rents for housing – are still rising at rates well above their averages. Furthermore, demand for goods and services in the economy was stronger than expected at the start of this year, which could lead to higher overall inflation if it were to continue.

On the other hand, Governor Bailey reiterated that the BoE must look beyond the most volatile components of services inflation and will closely examine the next inflation report for signs of a decrease in the persistence of services inflation. Given the tone of the MPC report and hawkish comments made at the press conference, we believe it will be unlikely that the BoE will implement a rate cut in September.

Growth picking up

GDP has risen quite sharply so far this year, but underlying momentum still appears soft. Following last year’s weakness, UK GDP increased by 0.7% in 2024 Q1 and is expected to have risen by 0.7% in Q2, compared with projections of 0.4% and 0.2% respectively in the May report. Based on readings from business surveys, underlying momentum in activity is judged to be weaker than headline GDP growth. Quarterly GDP growth is therefore expected to fall back to 0.4% in Q3 2024 and to 0.2% in Q4, broadly consistent with the current signal from surveys.

Market reaction and strategy positioning

Ahead of the BoE meeting, markets increased the probability of rate cuts in 2024 and assigned a 60% chance of a cut in the August meeting. UK fixed income markets rallied on the back of the August cut, while cable has cheapened (Exhibit 1).

Our J.P. Morgan Asset Management GBP liquidity strategies are well positioned to take advantage of the cut by the BoE. WAM remains at the top end of the current 40-50-day range, with a range of fixed maturity holdings in the 6-12 month part of the curve. Having locked in these holdings at attractive yields, the strategies will be able to maintain higher yields for longer.

Conclusion

The BoE’s decision to cut the Bank Rate to 5% reflects the normalisation in many indicators of inflation expectations, and its trend towards sustainably meeting the 2% target. The minutes of the August meeting show that the decision to support a rate cut had been “finely balanced” for some of the policymakers as “inflationary persistence had not yet conclusively dissipated, and there remained some upside risks to the outlook.” That, together with the MPC’s updated view on the upside risks to medium-term inflation, suggests to us that the committee will want to see more evidence that the disinflationary trend in the economy is intact before cutting rates again.

We expect the next step down to come in November, when the BoE will have more information in hand. There will be three more inflation releases between now and then, which will likely show inflation remaining close to the 2% target and price gains in services softening further.

GBP cash investors will be enjoying the higher yields for longer given longer term holdings in the JPM GBP strategies. Investors should consider diversifying across a range of tenors to ensure optimal balance of current and future returns.

Source for all data is Bloomberg and J.P. Morgan Asset Management, data as at 1 August 2024, unless otherwise stated.