Summer base rate cut now less likely even though inflation dips to 2%: here’s why

A Bank of England base rate cut this summer looks less likely as persistently high growth in services continues to thwart 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 services CPI inflation, which covers service activities in a broad base of sectors from retail to defense, fell just 0.2 percentage point month-on-month to 5.7 percent in May, down above city forecasts of 5.5 percent.

As a result, investors reduced their bets on interest rate cuts in June and August in the wake of the data, and markets now expect the Bank of England to wait until its September Monetary Policy Committee meeting.

The Bank of England has closely monitored services inflation as it charts its monetary policy path, but the rate continues to disappoint and is currently 0.4 percentage points above the bank’s May Monetary Policy Report.

Transport services drove most of the rise in services inflation in May, offsetting lower pressure from sectors such as recreation and culture, accommodation and restaurants.

Core inflation also remains elevated at 3.5 per cent, while the Bank of England will also be concerned about strong wage growth last month due to a jump in the national living wage.

Markets are now pricing in zero chance of an interest rate cut at tomorrow’s MPC meeting, according to Reuters, and just a 25 percent chance of a cut in August, down from a 50 percent chance before this. CPI reading.

Many City economists are more optimistic.

James Smith, developed markets economist at ING, said the latest ONS data “all but confirms the Bank of England will keep rates unchanged tomorrow” but said it “doesn’t necessarily change the game for the August meeting.”

He added: “We are… maintaining our call for the first rate cut to come in August, for a total of three cuts this year.”

Three rate cuts of 25 basis points each would take the base rate from its current level of 5.25 percent to 4.5 percent by the end of the year.

Smith said: ‘We will still receive another inflation report next month before the August meeting.

‘Any big surprise here could cause a further delay.

‘But listening to Governor Andrew Bailey in May, it seemed like he was interested in getting on with the task of lowering interest rates.

“And a bit like the European Central Bank, the Bank of England appears to be more confident in its inflation predictions than it has been in the last two years.”

Gabriella Dickens, G7 economist at AXA Investment Managers, also believes the bank will press ahead with a rate cut in the summer, but the asset management firm says it will settle for two rate cuts in 2024.

He said: “We expect services inflation to continue to decline in the coming months, partly due to base effects following strong increases in 2023.

‘More broadly, the MPC will have been encouraged by the weaker-than-expected April labor market data and will see a new round of both labor market and inflation data ahead of its August meeting.

“As a result, we remain comfortable with our proposal to cut the first 25 basis points in August, with an additional one in November.”