A Bank of England base rate cut this summer is looking less likely as persistently high services growth continues to frustrate the fight against inflation.
Consumer price inflation finally returned to the bank’s 2 per cent target last month after almost three years, according to the Office for National Statistics.
But CPI services inflation, which covers service activities across a broad base of sectors from retail to defence, eased just 0.2 percentage points month-on-month to 5.7 per cent in May, above City forecasts of 5.5 per cent.
As a result, investors slashed bets on June and August interest rate cuts in the wake of the data, and markets now expect the BoE to hold off until its September Monetary Policy Committee meeting.
Investors slashed bets on June and August interest rate cuts in the wake of the latest ONS data
Services inflation has been closely watched by the BoE as it plots its monetary policy path, but the rate continues to disappoint and currently sits 0.4 percentage points above the bank’s May Monetary Policy Report.
Transport services drove most of the upside in services inflation in May, offsetting easing pressure from the likes of recreation and culture, accommodation and catering.
Core inflation also remains elevated a 3.5 per cent, while the BoE will also be concerned about strong wage growth last month on the back of a jump in the national living wage.
Markets are now pricing zero chance of an interest rate cut at tomorrow’s MPC meeting, according to Reuters – and just a 25 per cent chance of an August cut, falling from a 50 per cent chance before this CPI reading.
Many City economists are more optimistic.
Core goods inflation has fallen sharply since its peak but services inflation remains stubbornly high
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James Smith, developed markets economist at ING, said the latest ONS data ‘all but confirms the BoE will keep rates on hold tomorrow’ but said it ‘doesn’t necessarily change the game for August’s meeting’.
He added: ‘We’re…sticking to our call for the first rate cut to come in August, with a total of three cuts this year.’
Three rate cuts of 25 basis points each would take base rate from its current level of 5.25 per cent to 4.5 per cent by year-end.
Smith said: ‘We’ll still get another inflation report next month ahead of the August meeting.
‘Any big surprises here could conceivably cause a further delay.
‘But listening to Governor Andrew Bailey back in May, it sounded like he was keen to get on with the job of cutting interest rates.
‘And a bit like the European Central Bank, the BoE seems more confident in its inflation predictions than it had been over the past couple of years.’
Gabriella Dickens, G7 economist at AXA Investment Managers, also thinks the bank will go ahead with a summer rate cut – but the asset management firm says it will settle with two rate cuts in 2024.
She said: ‘We expect to see services inflation continue to tick down over the coming months, in part due to base effects following the chunky increases in 2023.
‘More broadly, the MPC will have been buoyed by the softer-than-expected labour market data in April and will see a further round of both labour market and inflation data before their meeting in August.
‘As a result, we remain comfortable with our call for the first 25 basis points cut in August, with a further one in November.’
Investors are torn about when the BoE will cut rates and how far base rate will fall this year
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