Bank of England faces interest rate dilemma ahead of election

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by Glenn Dyer


What’s a central bank to do? Inflation is back on target after being above it for nearly three years, the economy is meandering, but there’s a looming election that could very well see the sitting government driven from office. So, when do you cut your key interest rate?

That’s the dilemma for the Bank of England on the eve of its monetary policy announcement tonight (Thursday, Sydney time) after headline inflation in the UK fell to 2% in May.

That’s the first time it has been this low since July 2021 (when it was on the way up). If the BoE cuts rates (and most economists do not expect it to do so), then it would join central banks in Canada, Sweden, and Switzerland in making first cuts to their key rates.

A cut is not forecast because the core measure and a measure of services inflation are still well above the target at 3.5%, down from 3.9% for core inflation, and 5.7%, down from 5.9% in April for services.

But the fact that headline inflation has reached the target will put the bank under enormous pressure from businesses, consumers, and especially homeowners to offer relief, even a little from the current 5.25% level, which has been in place since August of last year.

The under-pressure Tory government led by Rishi Sunak will be hoping for a cut to try and stave off defeat, while the opposition Labour Party wouldn’t say ’no’ if there was a trim, especially with high-profile frontbencher Rachel Reeves (the putative Chancellor in a Labour Government) saying Wednesday that “the cost of living crisis is still acute” for many families (for families, read voters).

Unlike May's meeting, today's decision will just be accompanied by a brief statement rather than the full monetary policy report and press briefing.

The May inflation report from the UK’s Office for National Statistics (ONS) was the last bit of inflation data ahead of national elections on July 4 (two weeks’ time).

The ONS said falling food prices were the largest contributor to the improvement in inflation last month, while car fuel (petrol and diesel) costs continued to see upward pressure.

Unseasonably bad weather led to the slowest increase in grocery sales in two years, new figures from UK market research firm Kantar showed Tuesday. Grocery sales rose 1.0% in the four weeks to June 9, marking the sixteenth consecutive monthly decline in food inflation, according to the index.

The BoE is likely to sit pat and wait for the election result, and then see what policies Labour introduces, especially as the UK is due to phase out its existing energy price cap towards the end of the year.

Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

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