Market News

Philip Aldrick, Bloomberg News

, ONS

(Bloomberg) -- The “feel-good factor” UK Prime Minister Rishi Sunak hoped would materialize during his term in office may instead arrive just in time to benefit his opponent, the Labour leader Keir Starmer.

The Bank of England hinted Thursday that policy makers could be ready to cut interest rates as soon as Aug. 1 — just 28 days after the general election that Sunak called for July 4. With Sunak’s Conservatives on track for a wipeout, it could be Starmer enjoying a tailwind from the lower borrowing costs and stronger growth Sunak has promised are on the way.

In office 14 years, the Conservatives are now paying the price for a cost-of-living crisis, historically high tax burden and crumbling public services. Sunak had counted on rate cuts and improving growth to lift the national mood. Instead, polls suggest that rising spirits will be Labour’s to enjoy.

“The first rate cut will be an indisputably good news story,” said George Buckley, Nomura’s chief European economist. “Rishi Sunak is missing out on all that.”

More evidence of improving sentiment emerged in reports on Friday, with retail sales rising more strongly than forecast and consumer confidence reaching its highest level in 2 1/2 years, before the cost-of-living crisis took hold.

In most economic cycles, central banks cut rates when the economy is weakening. This time, Buckley noted, the cuts will come as inflation subsides and growth picks up. 

The BOE on Thursday kept its key rate unchanged at a 16-year high. Policy was held for a seventh month at 5.25%, but a cut is moving into view. Two of the nine members of the Monetary Policy Committee were already voting for lower rates and, for at least three of the remaining seven, the decision to hold was “finely balanced,” minutes of the meeting said.

Those three are likely to be Governor Andrew Bailey, Deputy Governor Ben Broadbent and Deputy Governor Sarah Breeden, according to David Owen, chief economist of Saltmarsh Economics.

The rate cutters would then be in the majority. Markets are betting there’s a better-than-even chance policy will be eased at the next meeting. “Rates are too high, but services inflation is likely to decelerate and other indicators suggest rates should be cut in August,” said Gerard Lyons, chief economic strategist at NetWealth.

The idea that lower interest rates are on the way was a central part of the Conservative campaign before Sunak’s surprise decision on May 22 to call for an election before the summer recess. The announcement even took his Chancellor of the Exchequer Jeremy Hunt by surprise. 

Hunt repeatedly talked up the prospect of rate cuts, saying the “feel-good factor” would lift Tory chances. At that point a November election was expected.

But rather than wait for rate cuts, Sunak decided to move when he could declare victory over inflation. He called the election on the day the Consumer Prices Index fell to 2.3%, with the 11.1% peak in 2022 in the rear-view mirror. This week inflation dropped back to the 2% target.

The more salient political issue for hundreds of thousands of people is mortgage costs, though, a fact the Liberal Democrats highlighted on Thursday. Mortgage rates have crept higher this year as the central bank signaled it will take longer than expected to cut. 

“There is no end in sight for mortgage misery,” the party’s Treasury spokesperson Sarah Olney said. Sunak and former prime Prime Minister Liz Truss “owe the British public an apology.”

An August rate cut may not be a done deal, but the BOE is clearly moving in that direction. On May 9, Bailey said the first reduction could come as early as June. Broadbent has also said a cut was “possible” in the summer. 

The election effectively ended the chance of a move in June, though the BOE claimed on Thursday it “was not relevant.” Stephen King, senior economic adviser at HSBC Bank Plc, said stickier than expected wages and services inflation were also key. As the bank has been looking at those measures, policymakers “would still be feeling a bit uneasy about that,” he said.

Broadbent’s term ends on June 30, and his replacement, the former Treasury Chief Economist Clare Lombardelli, has never made monetary policy before. She has attended meetings, but only as the official observer. Lombardelli, who moved to chief economist at the Organisation for Economic Cooperation and Development in May last year, was appointed to the BOE by Sunak and worked closely with him during both the pandemic and cost-of-living crisis.

Her vote will now be crucial, and the big question is whether she is willing to dissent from the governor at such a critical moment in her first meeting. Broadbent never dissented from Bailey. “I would be surprised if she did not vote with the consensus of the committee,” Owen said.

--With assistance from Andrew Atkinson.

(Adds retail sales, consumer confidence reports)