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Financial markets

Bank of England's Rate Cut a "Significant Error"

Strategic Insights

— 2 min read

The Bank of England's Monetary Policy Committee (MPC) has made a significant mistake by lowering its main policy interest rate from 4.25pc to 4pc this month. Despite high and rising inflation, the MPC undermined its credibility by cutting rates. This decision has been met with financial market movements that suggest investors have a different view of inflation, with the cost of borrowing for the UK Government increasing sharply. This outcome, known as "rate-splitting," is a sign of growing financial instability.

Key Takeaways:

  • The MPC's decision to lower rates when inflation is still high and rising undermines its credibility, especially when it is sorely needed.
  • UK inflation remains high and is rising, with the consumer price index at 3.6pc in the year to June, the highest headline inflation rate since January 2024.
  • The UK's inflation outlier status is matched by its outlier status when it comes to long-term borrowing costs, with the 30-year yield at 5.57pc, easily the highest in the G7.
  • The cost of government borrowing has moved in the opposite direction of the policy rate, indicating that financial markets have a different view of inflation than the MPC.
  • Some mortgage providers have raised fixed-term lending rates following the MPC's cut, further exacerbating the "rate-splitting" issue.
  • The growing financial instability is a sign that market expectations have become unanchored from policymaker preferences.
  • The UK Government will have to pay more to borrow money, increasing its national debt, with the Office for Budget Responsibility estimating £148bn in borrowing for the 2024-25 fiscal year.
  • Successive UK governments have failed to borrow and spend responsibly, with the current Labour administration being increasingly reckless.

Statistics:

  • 3.6pc: the UK's headline inflation rate in the year to June (Source: Office for National Statistics).
  • 2pc: the MPC's inflation target (Source: Bank of England).
  • 4.5pc: the UK's 30-year gilt yield in August last year (Source: Bloomberg).
  • 5.3pc: the UK's 30-year gilt yield before the MPC's announcement on August 7 (Source: Bloomberg).
  • 5.57pc: the UK's 30-year gilt yield on August 9 (Source: Bloomberg).
  • 1.25 percentage points: the drop in the policy rate since last August (Source: Bank of England).
  • 0.8 percentage points: the rise in the UK's 30-year gilt yield since August last year (Source: Bloomberg).
  • £85bn: the Office for Budget Responsibility's estimate of UK Government borrowing for the 2024-25 fiscal year (Source: Office for Budget Responsibility).
  • £148bn: the actual UK Government borrowing for the 2024-25 fiscal year (Source: Office for Budget Responsibility).
  • £105bn: the amount spent on debt interest in the 2024-25 fiscal year (Source: Office for Budget Responsibility).
  • £16.4bn: the amount spent servicing the UK's existing national debt in June (Source: Office for National Statistics).

Sources:

  • "The Times" newspaper article by Liam Halligan.
  • Bank of England.
  • Office for National Statistics.
  • Bloomberg.
  • Office for Budget Responsibility.

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