Inflation in the U.K. has aligned with the Bank of England’s (BoE) 2% target in recent readings, yet the central bank may hesitate to reduce interest rates this week. On Wednesday morning, market pricing indicated a 60% probability of a rate cut at the BOE’s August 1 meeting, reflecting less certainty compared to expectations for the European Central Bank and U.S. Federal Reserve.

The uncertainty stems from divisions within the BOE’s Monetary Policy Committee (MPC). The committee’s decision to hold rates in June was described as “finely balanced,” with some members concerned about wage growth and high services inflation, while others focused on the broader disinflationary trend. In both May and June, seven MPC members voted to maintain rates, with two members advocating for a 25 basis point cut. The BOE’s statements have highlighted disagreements over the data needed to justify monetary easing.

Although U.K. inflation has cooled more quickly than in the U.S. and eurozone, price rises in the services sector remained high at 5.7% in June, surpassing BOE projections. Core inflation, which excludes energy, food, alcohol, and tobacco, stood at 3.5%.

The BOE’s upcoming decision is further complicated by recent economic growth and the appreciation of the British pound. Additionally, the six-week period from May 23 to July 4, marked by the U.K.’s general election campaign, limited central bank communications, including during the June 20 meeting.

Jonathan Haskel, one of the BOE’s more hawkish members, has expressed caution, noting persistent shocks from the wage-price system and a “tight and impaired” labor market. Haskel stated, “I would rather hold rates until there is more certainty that underlying inflationary pressures have subsided sustainably.”

Despite this caution, many economists anticipate that the “doves” will prevail in Thursday’s decision. ING’s research note suggested a leaning toward a rate cut, though uncertainty remains due to limited communication from officials since the election campaign began. James Smith, ING’s developed markets economist, highlighted that the decision might be swayed by the four or five middle-ground members of the MPC, who tend to act cohesively.

Market volatility could ensue from the BOE’s decision, with the start of a rate-cutting cycle potentially posing a challenge to the appreciating pound. Matthew Ryan, head of market strategy at Ebury, noted that the August meeting “provides an ideal opportunity for the first rate reduction” due to the accompanying quarterly Monetary Policy Report and press conference. Ryan suggested that while an immediate rate cut might lead to a short-term drop in the pound, positive communications and an upward revision of GDP forecasts could mitigate the extent of any decline.

(Adapted from Reuters.com)

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