According to Laith Khalaf, head of investment analysis at AJ Bell, the Bank has won the battle against inflation but the war isn’t over. In the following analysis, Laith comments on the Monetary Policy Committee report for August and its implications for the economy and for investors as he reminds us not to get too carried away quite yet saying:
“This interest rate cut marks a significant victory in the fight against inflation, but the war isn’t over. It’s been a torrid three years since the inflation genie sprung out of the bottle, and while the financial pain the Bank has inflicted on the economy has been swift and severe, we haven’t spun off into an inflationary cycle like in the 1970s.
“But inflationary pressures are still lurking. The energy price cap is expected to rise this winter, public sector pay agreements might push up prices, and a second Trump presidency in the US could stoke further global inflation through tax cuts, tariffs, and tough immigration controls. So there is little room for central bank complacency. Indeed, the Bank of England expects inflation to creep up towards 3% again towards the end of this year. Hence why four members of the Bank’s interest rate committee voted to keep rates on hold.
“One interest rate cut isn’t going to make a huge amount of difference at street level. But simply the direction of travel could unleash some animal spirits in the housing market, and in the wider economy. Having interest rates on a downward path will also help the new chancellor balance the books, though government debt interest payments are still uncomfortably high.
“The bad news for Rachel Reeves is the Bank reckons economic growth will remain limp, with GDP growing by just 0.8% over the next year. Then again, the Bank isn’t exactly known for its Tiggerish optimism when it comes to economic projections. This is evidenced by the fact the Bank has just upgraded its forecast for economic growth over the last 12 months to 1.5%, from 0.5% only three months ago.
“As for where interest rates go from here, there are mixed messages in the Bank’s latest statement. The fact four out of nine members wanted to keep rates on hold shows there is still a considerable amount of hawkishness in the interest rate committee. But according to the Bank’s figures, if it cuts rates in line with market expectations, inflation is forecast to be 1.5% in three years’ time. So that opens up the possibility of more drastic rate cuts than currently pencilled in by the market.
“It’s important to bear in mind that today’s interest rates aren’t remotely unusual by historic standards, and the extreme shock felt by millions of homeowners as they remortgaged is due to the unnatural monetary conditions which prevailed in the previous decade of ultra-loose monetary policy. Even if more rate cuts are forthcoming, no-one should be under any illusion that rates are going back to near zero. And, as ever when it comes to interest rates, it’s best not to count your chickens until they’re hatched.”
