Bank of England Pauses on Rate Cuts, Cites Gradual Approach

Gradual Approach to Monetary Easing

The BOE justified its decision to hold rates, citing elevated inflation in the services sector, which comprises about 80% of the U.K. economy. Despite the U.K. exiting a recession, growth has been sluggish, and the economy is projected to return to a moderate 0.3% growth per quarter in the second half of the year.

Wage growth in the U.K. also cooled to a two-year low in the three months leading to July, but it remained relatively high at 5.1%. The MPC emphasized that these mixed economic signals warranted a cautious approach.

Impact on Markets

Kyle Chapman, a foreign exchange analyst at Ballinger Group, said the BOE’s decision was “more decisive and more hawkish” than expected, which helped support U.K. government bond yields and lifted the British pound. The pound rose 0.72% against the U.S. dollar, trading at $1.3306, its highest rate since March 2022. Global equity markets also reacted positively, with the pan-European Stoxx 600 index rising by 1.45%.

Quantitative Tightening Continues

Alongside its interest rate decision, the BOE announced plans to continue its quantitative tightening (QT) program, reducing its stock of government bonds by £100 billion over the next 12 months through active sales and bond maturities. This move aligns with the prior period and meets market expectations, despite some forecasts for an acceleration of the program.

The BOE's balance sheet had expanded significantly during the pandemic, as the central bank purchased large amounts of bonds to stimulate the economy. However, the bank is now selling these bonds at a loss, subsidized by the taxpayer, as bond prices have fallen since they were originally bought. BOE Governor Andrew Bailey defended the QT program, saying it was necessary to make space for future monetary policy operations.

Influence of the U.S. Federal Reserve

The BOE's decision came just one day after the U.S. Federal Reserve initiated its own rate cuts, reducing rates by 50 basis points. Many strategists had anticipated a smaller 25 basis point cut from the Fed, but the larger reduction highlighted the concerns surrounding the U.S. labor market and broader economic slowdown.

Although the BOE's decision was likely locked in before the Fed’s announcement, global central banks are now assessing the broader implications of the Fed’s aggressive rate cut for global economic growth.

Outlook for Future Rate Cuts

The BOE lowered its key interest rate to 5% from 5.25% in August in a narrow 5 to 4 vote, and market expectations had leaned toward a pause until the next MPC meeting in November. Deutsche Bank’s chief U.K. economist, Sanjay Raja, reaffirmed his prediction for another rate cut this year, bringing the bank rate to 4.75%, followed by additional cuts in 2025.

Chapman noted that the BOE’s cautious stance reflects its more challenging position compared to the Fed. He suggested that Thursday's decision "reads rather like a lead-up to a cut in November."

Challenges of Quantitative Tightening

The BOE faces unique challenges with its QT program, being the only central bank to incur such significant losses on bond sales. According to Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, the BOE is "stuck between a rock and a hard place" due to its previous decisions. The continuation of QT could create difficulties for the U.K.'s new Labour government, which is set to deliver its first budget in October.

Conclusion

While the BOE's decision to pause rate cuts was widely expected, its gradual approach reflects ongoing concerns about inflation in the services sector and uncertainty around economic growth. With global central banks closely monitoring each other’s moves, all eyes are on the BOE’s next meeting in November, where further easing may be on the table.