After each inflation announcement, all eyes usually turn to the Bank of England, as markets speculate whether a rate cut is on the horizon at the next Monetary Policy Committee (MPC) meeting. But after April’s inflation figures were released, the MPC’s spotlight was quickly stolen by Rishi Sunak.
Standing outside 10 Downing Street, the prime minister called a general election for 4 July. With April’s headline inflation figure having fallen to 2.3%, Sunak claimed that inflation was “back to normal” and that the Conservatives’ plan to deliver economic stability was “working”.
Households and businesses across the country will be pleased to see that inflation is returning to more normal levels – even if price rises in some categories remain elevated. But can they expect the Bank of England to follow up with an interest rate cut at some point this summer?
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Some experts ruled out a June cut as soon as April’s inflation figure came in, as the headline rate did not fall by quite as much as expected. What’s more, the report revealed that core and services inflation remain sticky.
A general election could now throw another spanner in the works, some commentators believe, if the Bank of England wants to avoid its interest rate decision becoming politicised.
Does this mean that August (or indeed September) is now more likely for a first interest rate cut? We consider the key factors at play.
Will the Bank of England consider the election when timing interest rate cuts?
The Bank of England is owned by the government. It also carries out its activities within a framework set by the government. However, it describes itself as being “free from day-to-day political influence”. In other words, the Bank is responsible for acting independently when setting monetary policy.
This means a general election should have no bearing on the timing of an interest rate cut – at least in theory. However, in an ironic turn of events, some commentators think this desire to appear apolitical could actually result in the Bank delaying its decision.
“The Bank of England is going to want to skip changing the base rate around the time of an election,” says Mark Hicks, head of active savings at Hargreaves Lansdown. He points to market movements to support his claim, saying that savers are now expecting rates to stay higher for longer.
“The savings market has now fully priced in a delay to September. Before the announcement, August was still a reasonable possibility, and June was an outside chance. All that has changed,” he explains.
Despite this, it is important to remember that markets are not a crystal ball. They reflect sentiment. Of course, sentiment should not be ignored or discounted, but it should not be taken as gospel either.
Indeed, James Smith, developed markets economist at ING, doesn’t think the election will make much of a difference to the interest rate outlook at all.
He says: “I guess there are two questions. Will June’s decision become politicised? I don’t think it will, given both major parties are supportive of Bank of England independence. By contrast the actions of the Federal Reserve ahead of November’s US election are more likely to get drawn into the political arena.”
“Secondly, will any fiscal plans alter the course of BoE policy over the coming months? At the moment I don’t think they will, given Labour isn’t signalling any major deviation from the current government’s position on tax/spending – or not in such a way that’s likely to make major differences to the course of economic growth and inflation.”
What’s more, Smith adds that the Bank of England “can only act on official government policy”. In theory, this means that its decisions will pay no heed to any promises on the campaign trail. Instead, the MPC will have to wait for the first post-election Budget.
If Labour wins the general election (and the polls currently suggest the party is comfortably ahead), shadow chancellor Rachel Reeves has said the first Budget will take place in September.
When will interest rates fall?
The Bank of England has cancelled all public statements and speeches scheduled to take place during the election campaign. This is common practice, and follows the Cabinet Office’s election guidance. This will not impact the timing of routine announcements, however, including the upcoming interest rate decision on 20 June.
That said, at the Bank of England’s press conference on 9 May, CNBC’s Steve Sedgwick did ask Bailey about the prospect of an upcoming general election and what it might mean for the MPC’s decision-making.
Bailey said: “We will take the decisions at each meeting that are consistent with our remit. That’s our job and we will do our job.”
Prior to April’s inflation announcement, hopes had been high for a summer rate cut, with many experts divided on whether June or August was the most likely month. Economists polled by Reuters in mid-May were leaning more towards August, but only by a slim majority.
However, at 2.3%, April’s headline inflation reading came in slightly higher than the 2.1% many were expecting. What’s more, core and services inflation came in at 3.9% and 5.9% respectively. This could suggest inflation is stickier than many had hoped, particularly given that the UK is a very service-oriented economy.
With this in mind, Sanjay Raja, chief economist at Deutsche Bank Research, says it’s “unlikely” that the MPC will have to pay too much attention to the election cycle, as a rate cut was “put to rest” with the April CPI report.
Meanwhile, Smith says his “base case” is that the Bank cuts rates in August, “though this is because of the recent stickiness in services inflation rather than because of the election announcement”. However, he adds that “markets have been too quick to rule out a June rate cut given how divided the committee is right now.”
In April’s MPC meeting, eight committee members voted to hold rates at their current level of 5.25%, while one committee member voted for a rate cut. In May, the split shifted to seven-two. After the latest meeting, Bailey said that a cut was “neither ruled out nor a fait accompli”, emphasising the fact that the MPC would be led by the data. However, this was before the April inflation figures came out.
While the exact timing of the first cut is difficult to call, experts agree that we are now at the top of the interest rate cycle. Barring any major market shocks, the trajectory is downward from here. This is good news for mortgage holders and those paying off debts – however they will be hoping for cuts to come sooner rather than later.
It is less positive for savers, who are already starting to see the best savings deals get pulled from the market. The savviest among them will be eyeing up fixed-rate accounts as they look to lock in higher savings rates for longer.
What could a Labour vs Conservative government mean for interest rates?
Labour has released a statement attacking the economics behind the Conservative Party’s general election promises, saying that they could result in interest rate hikes further down the line.
The policies amount to “£71 billion of unfunded spending” or around 2% of the country’s GDP, the opposition party has said. It added that this could result in interest rates rising “by around 250 basis points, or 2.5%.”
The Conservatives have announced a string of new policies in recent days, including tax breaks for pensioners in the form of a new “triple lock plus” initiative. They have also promised to introduce national service for eighteen-year-olds, while replacing certain “rip-off degrees” with 100,000 new apprenticeships.
Labour has suggested that, in making these promises, Sunak is playing hard and loose with the country’s finances. Darren Jones, shadow chief secretary to the Treasury, said: “We know where this sort of kamikaze approach to the public finances leads: we’ve seen it before with Liz Truss. The Tories haven't learned the lesson, and now they're doing it again.”
Meanwhile, in an interview with The Times, Rishi Sunak has argued the very opposite. When asked whether a vote for the Conservatives was a vote for lower interest rates, he said: “Of course it is, because we are the party who has committed to bringing down inflation, which is the necessary condition for bringing down interest rates. And I think people can see we have delivered that.”
The Bank of England is responsible for acting independently when setting monetary policy. As such, a comment like this from a politician is unusual. The Times has noted this change in direction from Sunak, arguing that he has “traditionally been reticent to talk about interest rate cuts”.
Whether the Conservatives are really responsible for lower inflation is up for debate. Many experts say that factors on the global stage (such as slowing utility and petrol prices) have had more of a bearing – not to mention the pandemic receding further into the background. However, at the same time, it is worth mentioning that most economists believe interest rates have now peaked. Barring any shocks, we should start seeing cuts in the months to come.
What is clear is that both parties have ridden into this election campaign wearing the economy as their battle standard. And it is easy to see why, with the economy ranking as the most important issue for voters in the polls. It will continue to be a key point of focus as we approach polling day on 4 July.
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