The Bank of England maintained interest rates at 3.75% for the fourth consecutive time on Thursday, with the Monetary Policy Committee voting 7-2 to hold rates unchanged. The cautious approach comes as the US-Iran peace deal and softer-than-expected consumer inflation figures have significantly eased pressures to tighten monetary policy. However, external member Megan Greene and Chief Economist Huw Pill voted for an immediate quarter-point hike to 4%, citing concerns about persistent inflation despite the recent truce. As per Deutsche Bank analysts, the sting from the Iran conflict looks less than markets initially assumed, with the peak in CPI expected to end up well below last year's levels, potentially giving the BoE more time to assess second-round effects. The committee left its guidance unchanged and lowered its estimate of peak inflation to 3.25% in the fourth quarter of this year, below the 3.6% it had projected in April.
Consumer Price Index figures released on Wednesday delivered a positive surprise, with yearly inflation remaining steady at 2.8%, significantly below the 3.3% peak reached in March, and monthly inflation easing to 0.2% from 0.7% in the previous month. Governor Andrew Bailey noted that "oil prices have fallen in recent days and that's encouraging," though he cautioned that "the situation remains unpredictable and there is clearly a risk that energy prices remain elevated for an extended duration." Oil prices have dropped sharply from recent highs, with Brent Oil about 30% below the level it was at the previous BoE meeting, as the US and Iran advance towards a peace deal that might lead to resuming toll-free shipping through the Strait of Hormuz. The truce has allayed investors' most pessimistic scenarios for inflation, as oil this week dropped below $80 a barrel for the first time in three months, down from a peak of $108 a barrel. Lower energy prices and little evidence so far of inflation pressures broadening out in the UK are helping to ease pressure on the BoE to respond to the energy price shock by tightening policy.
Today's UK labour market report revealed significant deterioration, with official data showing 64,000 jobs have been lost since the Iran war started in February. The report revealed that payrolled employment increased marginally by 2k in May and the -100k drops in April was revised up to a still large drop of -53k. The MPC minutes said the latest jobs data was "consistent with a gradual loosening in the labour market." The report also revealed that regular private-sector pay growth has fallen to its weakest in five years. The committee emphasized that "the weakness in demand and the labor market was likely to lessen the strength of second-round effects," which should provide additional support for the BoE's cautious stance, as it reduces the risk of persistent inflationary pressures from wage growth.
The pound held losses against the dollar, trading more than half a percent weaker at $1.3219, while traders marginally pared bets on hikes, fully pricing one quarter-point increase this year and around a 30% chance of a second. The weaker pound has been driven in part by lower UK rates as market participants have scaled back BoE rate hike expectations. As per Luke Bartholomew, deputy chief economist at Aberdeen, "the BOE will be able to avoid the kind of monetary tightening that the European Central Bank has already started to deliver and that the Fed hinted at last night." The MPC minutes showed the committee agreed that the "appropriate policy response should be robust" if prices creep higher, with most members judging that the tightening in financial conditions since the Middle East conflict "provided insurance against inflation risks." The bank emphasized that it would "continue to monitor closely the situation in the Middle East" and that "the committee stands ready to act as necessary to ensure that CPI inflation remains on track to meet the 2% target in the medium term."
