The Bank of England will take its rate decision tomorrow, with increased wiggle room thanks to lower-than-expected inflation.
The Bank of England faces a much more flexible choice in its future monetary policy as fresh inflation data showed an unexpected fall. The Bank of England will convene tomorrow, one day after the widely expected decision by the Federal Reserve to stabilize rates.
Inflation dropped in the United Kingdom to 6.7% in August from 6.8% the month before. Markets were expecting the opposite effect: a jump to 7%.
The positive news was welcomed with optimism by markets, which were previously absolutely certain about another hike. Now, the possibility of a rate stabilization increased to 57%.
The Bank of England brought interest rates to a historic high of 5.25% with 14 consecutive hikes. They followed almost exactly what the Federal Reserve did on the other side of the Atlantic, and this month could have been the first diversion between the two central banks.
Core inflation, central banks’ favorite metric to decide monetary policy, had an even larger drop to 6.2% year-on-year. Core inflation measures consumer prices without volatile goods like food and energy. It represents a more accurate depiction of inflation across the economy.
The London FTSE 100 index jumped 0.80% following the news release.
Is a recession still possible?
The United Kingdom continues to have the highest inflation in the G7, well above the preferred 2% target. In the United States, consumer prices are much lower (albeit slightly increasing) at 3.7% while the Eurozone sits at 5.3% inflation.
“After all,” said senior economist at Berenberg Kallum Pickering, “monthly data can be volatile and, despite the sharp fall in core inflation, price pressures remain well above the BoE’s 2% target. In addition, underlying demand remains mostly resilient, and wage pressures are still elevated – which adds to services cost pressures.”
The British economy is feeling the pressure of high interest rates, with July GDP contracting 0.5%, more than expected.
Although the International Monetary Fund revised GDP expectations for the UK higher, growth in 2023 will be minimal with risks of recession in early 2024.
The Bank of England, however, also recognizes that the British economy has been surprisingly resilient. The Office for National Statistics recently revised post-Covid GDP to 2% higher than previously thought.
It’s a hard thread to balance, and will likely lead to stagflation in the best of cases. High interest rates will have an impact, whatever the Bank of England decides tomorrow.
