Press release

28 Jul 2023 London, GB

The case for another rate rise is getting weaker, but the Bank of England may still raise rates again – EY ITEM Club comments

With better recent news on inflation, leading indicators of price pressures falling significantly, and the Bank of England’s new forecast likely to show inflation heading towards zero over the next few years, the EY ITEM Club thinks the case for another rate rise in August is weak.

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  • With better recent news on inflation, leading indicators of price pressures falling significantly, and the Bank of England’s new forecast likely to show inflation heading towards zero over the next few years, the EY ITEM Club thinks the case for another rate rise in August is weak. But the Monetary Policy Committee (MPC) could still be influenced by past developments, and may feel pressure to be seen to be doing something about still-high inflation. As such, it appears likely that the MPC will increase rates next week.
  • Still-significant momentum in pay growth over the late spring coupled with the fact that inflation remained high in the latest data will probably provide sufficient evidence to the MPC of persistence in price pressures.  
  • But the EY ITEM Club thinks the MPC will revert to a more ‘standard’ 25bps increase in rates next week, rather than repeating June’s 50bps rise. Headline inflation in June broke what had been a long run of upside surprises, while services inflation came in below the MPC’s expectation. Pipeline price pressures are now falling. And higher market rate expectations, the stronger pound and lower gas prices mean the Bank of England is likely to forecast an even bigger medium-term undershoot of the 2% target than three months ago.

Martin Beck, Chief Economic Advisor to the EY ITEM Club, says: “On balance, the EY ITEM Club thinks the MPC will announce another rise in Bank Rate on 3 August. But a less significant inflation backdrop than of late means it’s now more questionable whether further monetary tightening is needed at all. At the very least, recent developments should give the MPC leeway to limit the next rise to 25bps, rather than repeating June's 50bps increase – something which the markets had, until recently, anticipated.

“Given the lag of 18 months to two years between changes in interest rates and their full effect on the economy, the MPC should, in theory, be focused on outlook for inflation, not its past performance, in setting monetary policy. On that front, developments have generally been promising since the MPC met last in June. The price paid by manufacturers for raw materials and other inputs fell outright in June for the first time since late 2020, down from a peak rise of almost 25% last summer. Growth in prices charged by manufacturers was also at a two-and-a-half year low. Both developments point to a rapid fall in inflation ahead. 

“Meanwhile, movements in the last three months in some of the assumptions which underpin the Bank of England’s inflation forecast point to a significant cut in that forecast in their updated projections (also released on 3 August). One is a significantly higher market path for interest rates. For example, Bank Rate is now expected to average 5.8% in Q1 2024, versus 4.6% at the time of the Bank of England's last forecast in May. The Bank of England's own research suggests that this could ultimately knock over 1ppts off inflation. A second is the stronger pound – sterling's trade-weighted value is currently around 3.5% higher than the 2023 average level assumed by the Bank of England in May. Third is a further fall in wholesale gas futures prices, with latest prices for delivery next year down almost 10% on three months ago. In May, the Bank of England forecast that Consumer Price Index (CPI) inflation would fall to only 0.7% in mid-2025, assuming Bank Rate was held at 4.5%. Developments in the last three months mean the new forecast could show inflation falling close to zero by the same date. 

“Of course, the Bank of England's inflation forecast for May didn't stop the MPC raising rates that month, nor in June. And the committee's concerns about upside risks to inflation mean the EY ITEM Club doesn’t think the new forecast will deter another rate rise this month. The MPC will likely be concerned about the latest wage numbers coming in stronger than expected. Year-on-year growth in average total pay, regular pay and private sector regular pay (the latter the Bank of England's go-to indicator of price pressure coming from the labour market) in the three months to May all reached record or joint-record highs (excluding the distortion-affected pandemic period for the total and private sector measures).  

“What’s more, inflation remained high in absolute terms in the latest data. That said, the headline CPI measure moved to 7.9% year-on-year in June, almost a full percentage point down on May's reading. This was below consensus and in line with the Bank of England's May forecast, following two consecutive monthly overshoots. Core inflation eased to 6.9% from 7.1%, with the month-on-month increase just 0.2%. And services inflation also fell, contrary to the Bank of England's expectations.

“So even a backwards-looking approach to setting interest rates doesn’t appear to provide a conclusive case for tighter policy, particularly given the scale of rate rises already working their way through the system. Nonetheless, the EY ITEM Club thinks the pay numbers, along with a possible desire to be seen doing something to bring inflation down, will be enough to sway the MPC into increasing rates again. But an August rise should mark the summit, or near-summit, of the current rate rise cycle.”