Press release

21 Sep 2023 London, GB

No change in rates, and the EY ITEM Club thinks the next move will be down – EY ITEM Club comments

Recent economic data meant September’s interest rate decision had looked very finely balanced. In practice, the MPC came down on the dovish side, keeping Bank Rate unchanged at 5.25%.

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  • August’s downside inflation surprise, a looser labour market and less concerning signs from some pay measures were enough to convince a narrow majority on the Monetary Policy Committee (MPC) to vote in favour of keeping Bank Rate on hold in September’s meeting. While the MPC didn’t close the door to more rate rises in the future, the EY ITEM Club thinks the next move in borrowing costs will be down.
  • With evidence of the adverse economic effect of past rate rises building, disinflationary forces growing and interest rates in other major economies probably at, or near, their peaks, the EY ITEM Club thinks today’s decision to pause was a sensible one, reducing the risk of overtightening monetary policy.  
  • The question now is when rate cuts might happen. The Bank of England’s next set of economic forecasts, due in six weeks, should offer some clues on that. In the meantime, the latest policy statement stuck to the MPC’s previous ‘high-for-longer’ message. But events mean that the MPC’s signalling may not prove an exact guide to the actual path of interest rates.
  • If inflation continues to surprise to the downside and tentative signs in the latest data that pay growth is on the turn continue to build, the EY ITEM Club thinks rate cuts could commence early next year. But the recent rise in oil prices, if sustained or extended, could delay loosening until further into 2024.

Martin Beck, Chief Economic Advisor to the EY ITEM Club, says: “Recent economic data meant September’s interest rate decision had looked very finely balanced. In practice, the MPC came down on the dovish side, keeping Bank Rate unchanged at 5.25%. The growing effect of past rises in interest rates, inflation in August coming in well below expectations, alternative measures of pay showing less heated growth than the official series and the jobs market cooling noticeably were enough to convince a majority to forgo another rate increase.  

“That said, the latest decision was a close call. While five members voted to keep Bank Rate at 5.25%, four were in favour of a 25bps rise. And the MPC didn’t close the door to further rate rises, sticking to its previous line that “further tightening in monetary policy would be required if there [was] evidence of more persistent inflationary pressures.”

“So, today’s decision could be framed as a pause, allowing the committee to wait for new data to get a clearer picture of the economic and inflation situation before the next meeting in November, when the Bank of England will also be publishing updated forecasts for the economy. But the EY ITEM Club thinks the odds of today’s decision representing a ‘skip’ before rates rise again are low. Inflation should continue to fall, pushed down by lower energy bills, the lagged effect of deflation in producers’ input prices and a significant deceleration in money supply growth. Pay growth should moderate too, reflecting lower inflation expectations, weaker demand for workers and a fall in job-to-job moves. And the economy is looking weaker than the Bank of England had expected, reflected in a cut to its forecast for growth in Q3 to 0.1% from 0.4% previously.

“More uncertain is when rate cuts will happen. The latest policy statement stuck to the MPC’s previous ‘high-for-longer’ message, repeating language from recent meetings that “monetary policy will need to be sufficiently restrictive for sufficiently long to return inflation to the 2% target sustainably in the medium term”.

“But it’s not implausible that the MPC’s messaging doesn’t prove an exact guide to the actual direction of policy. Were inflation to repeat August’s downside surprise and were signs that pay growth is on the turn to continue to build, the committee could change its stance, with cuts perhaps beginning early next year. On the other hand, the recent increase in oil prices, if it’s sustained or intensifies, could slow inflation’s descent and raise renewed concerns around ‘second-round’ effects, delaying rate reductions until well into 2024.    

“The scale of monetary tightening since late 2021 and the fact that the impact has yet to come through in full, mean previous rate rises could present a substantial obstacle to growth in the near-term. But confidence that rates have now peaked, versus expectations only a few weeks ago that Bank Rate could breach 6%, presents a positive and means the recent decline in quoted mortgage rates off the back of a fall in market rate expectations should have a little more to run.

“The Bank of England remains unique among major central banks in actively selling off the assets bought under the previous quantitative easing programme. And the MPC voted in its latest meeting to increase the scale of those sales over the next 12 months, making the UK central bank even more of an outlier. So even with rates on hold, monetary policy will continue to tighten.

“Opinions differ on whether Quantitative Tightening (QT) represents a meaningful tightening of monetary conditions. The Bank of England argues that, under current market conditions, the effect is small. But other authorities have reached the opposite conclusion. A faster pace of QT will also add to the pressures faced by the public finances, since the Treasury is committed to indemnifying the Bank of England on any losses made on gilts at the point of sale, at a time when gilt issuance is already high.”