A split monetary policy committee has a big decision to make

The task for the nine-person MPC will be to weigh up the latest economic data and judge the most appropriate path for UK borrowing costs, and savings rates. This won’t be easy. For the first time since the interest rate increase of August 2023 - which generated a three-way voting split on the MPC - there is high uncertainty in financial markets on the most likely outcome. Traders of interest rate-sensitive options see the decision as a genuine coin toss between no change, and a quarter point cut. This reflects a committee that must interpret a raft of conflicting and noisy data. So how have we arrived at a position where there is such high level of uncertainty?

The first thing to note is that uncertainty is not in itself a bad thing. Neither Committee members, nor the Governor Andrew Bailey are duty bound to provide nods and winks to financial markets, households, and businesses. Indeed, it is genuinely possible that there are enough floating voters on the MPC this time around that such overt signalling - as appears increasingly the approach of the US Federal Reserve Bank - is simply not possible. I would venture that there are at least six members of the MPC for whom the data from the latest Bank of England economic forecast - and anecdotes from the Bank’s network of regional agents - will influence their August vote. That makes pre-emptive commitment to a particular policy something of a fool’s errand.  

The second point of debate is how durable the recent fall in UK inflation will be. Price growth has slowed from more than 11% a year to 2% a year in just eighteen months. At its peak, food price growth was described by Governor Bailey - injudiciously in my view - as “apocalyptic”. Such rhetoric has whipsawed to such a point that the Chief Economist at the Office for National Statistics felt comfortable in May describing the UK economy as “going gangbusters”. Economies do not shift their characteristics as nimbly as this. When it comes to price growth it is a valid concern that inflation may see something of a resurgence when goods and energy price deflation levels out towards the end of 2024. Drewry’s World Container Index reports global shipping rates have doubled since early May. Shipping costs were a big feature of the last surge in inflation so central bankers will be nervous of being seen to twice ignore this key supply chain indicator. Even should shipping costs prove a false alarm, there is still anxiety that high wage and services sector inflation – without any breakthrough in UK productivity growth – is inconsistent with low and stable inflation. Price growth continues to grow by between five and six percent across domestic, non-tradeable parts of the UK economy.   

Third, what impact will events in the world’s two largest economies - the US and China - have on the Committee’s thinking? Emerging softness in the Chinese economy has led to two interest rate cuts in under a week, whilst US policymakers have signalled willingness to make their first rate cut in mid-September. This backdrop has helped push the value of the Pound to an eight-year high. Concerns at the Bank about imported price inflation can be somewhat tempered by the Pound moving on from its Brexit and Mini Budget weaknesses.     

Fourth, there is a human side to what can often be seen an abstract, data-driven decision on interest rates. The new Deputy Governor, Clare Lombardelli, is at her first MPC meeting as a rate-setting member. External member, Jonathan Haskel, will be at his last. In theory these factors make no difference. But first impressions and legacies are powerful influences that impact even the most cerebral.  Markets must judge what impact this will have on their votes.

Fifth and finally, whilst delivering low and stable price growth is the mandate for the Committee, decisions are always taken in the context of growth and employment. Growth is expected to be upgraded again in the Bank’s forecast that, again, looks too pessimistic for 2024. GDP growth of 1.0% and a return to per capita growth is nothing to crow about but given Bank staff expected GDP growth of just 0.25% at the start of the year a quadrupling of this rate will again lead to accusations that the Bank has become systematically pessimistic. Will this sway internal Committee members to vote for a rate cut that would help encourage a lower rate of household saving, and higher business investment? The new Chancellor, Rachel Reeves, has made little secret of her desire to see this happen, not least as it would help with the difficult fiscal bind she now finds herself in.      

All said this is an opinion column, and it would be remiss not to offer one. I would cut UK interest rates this week. The balance of risk has moved decisively from runaway price and money growth of 2022/23 to interest rate policy that risks being too tight. Skilled messaging can convince businesses and households that rates can be lowered modestly whilst still providing a squeeze on remaining pockets of high price growth. Around a third of UK mortgage holders are still to refinance at post-2021 interest rates. It is a similar picture for company debt. So there is still disinflationary pressure to come from previous policy decisions and that should comfort policymakers that they are not returning the punchbowl too soon.

By following an interest rate path already laid out by central banks in Canada, Switzerland, the Eurozone, and Sweden the UK would not be an outlier. After the last eight years of economic unilateralism a period of following our international peers would be a welcome development.