Bank of England's rate cutting on hold after air fares take off

By Jamie Chisholm

The Bank of England is unlikely to join its U.S. and eurozone peers in trimming borrowing costs in September, stymied by stubborn service sector inflation.

Interest rate futures markets showed the probability of the BoE cutting its main bank rate by 25 basis point at its Sept. 19 meeting falling on Wednesday from a roughly 33% chance to around 24%, according to Reuters.

The dwindling probability that the BoE would follow up August's quarter of a percentage point cut to 5% with another same-sized reduction followed a fresh update on U.K. inflation

The Office for National Statistics on Wednesday said that Britain's annual consumer price inflation in August remained the same as the previous month at 2.2%. That's just a fraction above the BoE's 2% target, having dropped from a cyclical peak of 11.1% touched in October 2022.

However, traders quickly noted that services inflation, the BoE's favored measure of domestic price pressures, increased from 5.2% in July to 5.6% last month - powered in part by a large rise in airfares inflation from minus 10.1% in July to plus 11.9% in August.

"Some of the rise in services inflation in August was due to airfares which are volatile. But there's no denying that services inflation is still too high for the Bank of England's liking," said Ruth Gregory, deputy chief U.K. economist at Capital Economics.

This "suggests the Bank of England will almost certainly press the pause button on interest rate cuts on Thursday. We continue to expect the next 25 basis point rate cut to take place in November," Gregory added.

The lower chance of an imminent U.K. rate cut pushed up the pound (GBPUSD) by 0.4% to $1.3212, close to its strongest level since March 2022, and forced 10-year gilt yields BX:TMBMKGB-10Y higher by 5.5 basis points to 3.829%. The FTSE 100 UK:UKX equity index fell 0.6%.

Still, even though a September rate cut now seems unlikely, futures markets are still pricing in two more 25 basis point reductions in bank rate this year as the BoE places greater emphasis on supporting the economy, according to analysts.

"Policymakers' focus is shifting from inflation to growth as an economic soft patch takes shape against the backdrop of a receding fiscal impulse, paving the way for a BoE easing cycle to kick in," said Konstantinos Venetis, senior economist at TS Lombard.

"We pencil in another couple of rate cuts this year (November and/or December) and expect Bank Rate to reach 3.5% by December 2025 based on our central economic forecast," Venetis added.

Sanjay Raja, chief U.K. economist at Deutsche Bank, also said that a November rate cut was a favored option because by then the BoE will have more information on the fiscal outlook, with the government's Autumn Budget slated for the end of October.

"All in all, despite the potential dovish Fed backdrop, we think the MPC remains on course for a dovish hold on Thursday," said Raja.

-Jamie Chisholm

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09-18-24 0839ET

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