Key Takeaways

• Market odds for the Bank of England to cut rates in August are better than 50:50. We are less optimistic and suggest caution.
• GDP growth has improved, real incomes and confidence are rising, business investment has been strong – all this reduces the pressure to cut.
• There are real concerns about wage inflation too. The 10% hike in the minimum wage in April has fed through to wages generally and the new government plans to extend the minimum wage to young adults.
• There is also bad news to come on energy bills with the Ofgem price cap set to rise by 12% in October.
• In Europe, the economy continues to stutter and further ECB rate cuts are likely.
• Stable rates in the UK with an improving economy, versus lower rates and slower growth overseas, mean that sterling is likely to continue to strengthen

Transcript 

We’ve had lots of important news for UK interest rate prospects recently: the new government with a radical agenda, key economic data both here and abroad – even the attempted assassination of Donald Trump, affects the outlook.

The markets think the odds that the Bank of England (BoE) will cut rates when they meet early next month are better than 50:50. And expectations are for at least two cuts by year end. I’m less optimistic in the near term even though the international background has become more favourable for rates cuts. That suggests that sterling strength will continue. Let me explain why.

Over in the US, the attack on Donald Trump has further increased his chances of winning the election, even if the Democrats persuade Biden to stand down. Although there are concerns that a Trump Presidency may push up bond yields by cutting taxes he would also raise revenue via tariffs. The bigger effect may be to boost US equities. In the near term though, the Federal Reserve will be more focussed on the recent data showing lower inflation and slower growth. US interest rates have a disproportionate effect on market pricing for rates in other countries, including the UK.

But the BoE will be more focussed on domestic factors and these suggest caution. First and foremost is the big improvement in UK GDP growth. This is hardly surprising: inflation has fallen, real incomes and confidence are rising, and despite all the doom and gloom surrounding the outgoing government, business investment has been strong. That reduces the pressure to cut rates. And although inflation has hit the 2% target and will stay there for the next few months, much of that reflect base effects not least from tumbling household energy bills.

There are real concerns about wage inflation. This was boosted by the 10% hike in the minimum wage in April and has clearly fed through to wages more generally and the price of labour-intensive areas like services. I do think wage inflation will fall but it starts from a very high level and the new Labour government have already said that they will extend the minimum wage to young adults and are likely to push the overall level higher. There is also bad news to come on energy bills with the Ofgem price cap set to rise by 12% in October. The Budget, likely date November, will stick to the inherited fiscal rules but with more spending financed by increased capital taxes, the net effect is likely to boost demand. At the last two meetings of the BoE rate-setting committee, two of the 9 members voted to cut rates. I reckon they’ll remain in a minority at the next meeting on 1^st August.

Over in Europe, the economy continues to stutter and, with inflation falling there too, further ECB rate cuts are likely.

Stable rates here with an improving economy versus lower rates and slower growth overseas, mean that sterling is likely to continue to strengthen. We shall see. May I end by congratulating Spain on beating England in the Euros 2024. The better team won without a doubt.

Until next week, goodbye.

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