Bank of England “Pause” Seen in Pipeline after S&P Survey Hints of Inflation Deceleration

“But no internal member of the Committee has laid the groundwork for a pause in recent speeches” – Pantheon Macroeconomics.

Some economists say a widely monitored private sector survey likely reveals the trajectory of UK inflation up ahead and that it could lead the Bank of England (BoE) to “pause” its interest rate cycle soon, though the broader implication would be that it could become appropriate for the BoE to consider cutting borrowing costs in the near future

Monday’s S&P Global surveys of the manufacturing and services sectors suggested that prices charged by private sector firms rose at their slowest pace since February 2021 this month, and Pantheon Macroeconomics says some of the survey results may be offering insight into the outlook for the official measures of inflation.

“Our [chart below] shows that this points to the MPC’s measure of “core services” prices, which removes transport services, package holidays and education prices from the services CPI, rising at a 4% annualised rate,” says Samuel Tombs, chief UK economist at Pantheon Macroeconomics.

“We think that such a deceleration, if mirrored by the official data over a few months, would persuade the MPC that it has raised Bank Rate enough, given the lags in transmission of monetary policy to the economy and the infrequency with which many services prices are recalibrated,” he adds.

July made for five of six months in which the pace of increase in prices charged by private sector firms had moderated while S&P Global has said the ongoing increases are being driven by rising pay growth within the labour force, which has reportedly led to a large uplift in “average cost burdens.”

The survey comes after the official measure of inflation was reported lower for the first time since April just last week but for the month of June and suggests the Bank of England (BoE) may not have been too far off, after all, when projecting in February and May that inflation would likely fall to around 7% in July and 4% by year-end.

“UK inflation watchers were pleasantly surprised for a change with June’s headline and core numbers coming in lower than expected. Overall CPI fell from 8.7% y/y in May to 7.9% in June – the lowest rate since March 2022,” says Ross Walker, chief UK economist at Natwest (LON:NWG) Markets.

“Significantly though, core and services CPI are still at their second-highest rates in 31 years,” he adds in a Monday blog post.

Walker and the Natwest Economics team say that while inflation fell notably in June – from 7.1% to 6.9% if food and energy items are set aside – ongoing high levels of inflation mean they expect the Bank of England to raise Bank Rate further from its current 5% level over the coming months.

Others also see a high risk or chance of further increases including Pantheon’s Tombs and colleagues who’ve tipped Bank Rate to reach 5.5% before the year is out.

“It’s now conceivable that the MPC could opt for a Fed-style “pause” next week, given the slowing in business activity growth and CPI inflation. But no internal member of the Committee has laid the groundwork for a pause in recent speeches,” Tombs says.

However, the BoE’s February and May forecasts would indicate the BoE has already ‘overtightened’ its monetary policy by lifting Bank Rate too far if inflation can be assumed to remain around 7% this July and then reach something like 4% by year-end.

The BoE’s February and May forecasts suggested market-implied expectations for Bank Rate were already too high back then as and when they envisaged at the time a benchmark interest rate of 4.5% and then 4.75% by year-end, which could have important implications for monetary policy up ahead.

One of these implications would be that rather than raising interest rates further at any point, it might actually be more appropriate for the BoE to consider cutting borrowing costs in the near future, given how long the BoE has been raising Bank Rate for already and how the rate impacts the UK economy.

The BoE began raising interest rates in December 2021 and was the first major central bank to begin doing so while its interest rate changes could be expected to impact the economy relatively quickly due to the structure of the national mortgage book in which rates are fixed over 02-year and 05-year fixing periods.

This means at least half of mortgage borrowers would have refinanced loans at some form of higher rate by year-end, with many rolling over to very substantially increased borrowing costs and with more set to do so as time goes on.

But everything depends on the actual inflation measured by the Office for National Statistics and how confident the BoE can be in the effectiveness of Bank Rate as an inflation-fighting instrument since the upheaval created by the coronavirus pandemic and the Russian invasion of Ukraine.

Many economists have asked since then whether central banks can really expect to control inflation in the way prescribed by their current mandates while some have suggested they should be willing to simply accept that inflation is likely to be higher than desired for some time, though all central banks have resisted this notion.