by The Bank of England risks becoming public enemy number one again this week. On Thursday the Bank’s Monetary Policy Committee will announce its latest decision on interest rates. If he surprises the markets by cutting rates just two weeks before election day, some will accuse him of trying to curry favor with the Conservatives.
On the other hand, if it stays, despite better news on inflation and worse news on growth, others will conclude that the Bank is biased towards Labour. Either accusation would be very unfair. But how will the MPC navigate its way through this political minefield?
As a starting point, the MPC did not change interest rates at the meeting immediately before the general election. However, there have been only six general elections since the Bank was given the independence to set rates in May 1997, and interest rates have not changed at all during most of this period.
There is certainly no rule against individual MPC members voting to change rates during an election campaign. Sushil Wadhwani voted to raise rates in June 2001 and Sir Andrew Large did the same in April 2005. Perhaps the most interesting precedent is November 2019, when two members who previously voted on for no change to cut – Jonathan Haskel (still on the MPC) and Michael Saunders.
We can safely conclude that the two current members who are already voting for a cut – Swati Dhingra and Dave Ramsden – will do so again this week. The question then is whether three or more of the other seven members are ready to join them, creating a 5-4 majority to cut rates.
There are a number of good reasons why the Bank of England may be waiting a little longer.
UK inflation has been relatively subdued, particularly “core” (excluding food and energy) and services sector inflation. Forward-looking surveys of business activity and consumer confidence are encouraging, with the broad money and credit aggregates looking healthier.
So it is entirely reasonable (and desirable) for the MPC to have a range of views here. A number of prominent former members have been calling for the rate to be cut in recent months, notably the Bank’s former chief economist Andy Haldane. But others have argued for caution, including Andrew Sentance. These experts are neither fools nor knaves.
For what it’s worth, my own view is that the new information over the past week has strengthened the case for a cut on Thursday. The economy failed to grow at all in April. Hopefully the wet weather didn’t affect activity but the second quarter was off to a poor start.
The labor market is also continuing to cool, with unemployment ticking higher and early evidence for May suggesting wage pressures are now easing after the jump in April.
Meanwhile, the results of the Bank’s own surveys should reassure those still worried about a “wage-price spiral”.
Earlier this month the Bank’s Decision Panel reported that businesses’ expectations of wage growth in the coming year fell back to 4.1pc in May, from 4.6pc in April.
We can now add the Bank’s quarterly survey of the public’s expectations of inflation over the next 12 months. The average forecast has fallen to 2.8pc, down from 3pc in February. This is well below the peak of 4.9pc in August 2022 and back in line with the 2000-21 average.
May’s inflation data could be the deciding factor. Manually, this will be released to the public on Wednesday morning, which is the day the MPC will decide.
The headline measure fell slightly less than expected in April, to 2.3pc, prompting markets to scale back their expectations for the timing of the first interest rate cut.
Indeed, all but two of the 65 economists surveyed recently by Reuters expected the Bank to wait until August, with the two outliers going for September.
But the May numbers are likely to show that inflation is finally back to the 2pc target, or even lower. This would of course make it much easier for the Bank to cut rates this week, especially if core measures and services are also much lower.
The balance, therefore, could still shift in favor of an early cut. This would not be particularly dangerous. A quarter point cut would leave UK interest rates at 5pc, well above a “neutral” level. Combined with the Bank’s relatively aggressive selling of government bonds – the controversial policy known as quantitative tightening – this would continue to affect inflation.
In addition, inflation is falling to the 2pc target in the Bank’s own forecasts and will remain there or there for the next few years, even on the basis of market expectations for a string of rate cuts.
The improvements in business and consumer confidence are also based on hope that lower inflation will allow interest rates to be cut. If the Bank of England fails to deliver soon, the recovery could still be snuffed out.
In line with this, the latest survey by the Royal Institute of Chartered Surveyors found that the recovery in the UK housing market is slowing again, as expectations of rate cuts have faded.
These factors should put to rest any concern about political optics. But whatever the case, the latest polls hardly suggest this is a crunch election where the latest interest rate decision could swing the outcome either way.
If there is enough new information to justify cutting interest rates – and if markets were not completely blindsided by this – then this is what the MPC should do. Fingers crossed for a pleasant surprise.
Julian Jessop (@julianhjessop) is an independent economist. Jeremy Warner is away
