Soaring bond yields indicate dwindling hopes for interest rate cuts, with benchmark borrowing costs nearing record highs last seen in 1998.
The Bank of England has decided to keep interest rates on hold for the rest of the year, according to traders, as the UK grapples with rising inflation and a slowing economy. This decision comes amidst a delicate balancing act between controlling inflation and supporting economic growth.
Inflation Control
Holding rates steady would help ensure inflation does not rise further and remains on a declining path towards the 2% target in the medium term. Inflation is expected to peak around 4% soon due to higher food prices but then gradually fall, so stable rates help anchor inflation expectations.
Economic Growth
The UK economy is slowing, with GDP growth weakening and some underlying signs of fragility such as weak household spending and falling business investment. Maintaining rates could avoid stimulating excess demand that might re-accelerate inflation, but it may also restrain growth further, given the already sluggish momentum.
Households
Keeping rates on hold means borrowing costs remain relatively high, which could limit consumers’ ability to spend, especially on mortgages and loans. This, coupled with the recent rise in food and energy prices, further burdens households.
Labour Market
Job market signs of slowing, like rising unemployment and reduced vacancies, alongside declining wage growth, suggest less inflationary pressure from wages. Stable rates could allow the Bank to monitor labour market conditions without tightening further.
Future Rate Outlook
The Bank’s cautious approach reflects uncertainty around inflation trends and global developments. While some experts anticipate possible further rate cuts later in 2025 or 2026, the Bank's messaging indicates it may pause to assess inflation persistence before adjusting policy again.
The Broader Economic Picture
The economic situation has not been mentioned in the previous bullet points. However, recent official figures show economic growth slowing sharply and debt ballooning, with unemployment rising by more than 200,000 since Labour came to power. Global events, such as US inflation fears last week, have sent bond yields higher across the world.
Bond markets have shown volatility over the past year due to questions about Reeves' ability to bring public finances under control. U-turns on winter fuel payments and welfare reform have tied Rachel Reeves' hands as she tries to repair the public finances.
Political Implications
The dismal economic picture has underlined serious worries about Rachel Reeves' handling of the economy. Simon French, chief economist at broker Panmure Liberum, suggested that Rachel Reeves should resign if Keir Starmer does not back her efforts in the face of resistance from Labour backbenchers.
Consumer Sentiment
A report from financial firm S&P Global showed that the latest rate cut boosted consumer sentiment, implying that a pause in cuts will have a damaging impact. The poll of 1,500 households by S&P Global came 'hot on the heels' of the Bank's decision to cut rates to 4% earlier this month. Maryam Baluch, an economist at S&P, stated that the easing of monetary policy has been positively received by households across the country.
Yields on Long-term Bonds
The yield on benchmark ten-year UK bonds has climbed to more than 4.76%, the highest level since late May. Moreover, the yield on 30-year UK bonds has risen above 5.62%, close to levels last seen in April.
The Financial Black Hole
The Chancellor is facing a £50 billion financial black hole, exacerbating concerns about the UK's public finances. The prospect of tax increases becomes more certain due to a downturn in the market for UK bonds.
In summary, holding interest rates steady aims to maintain inflation control without destabilizing a slowing economy, but it constrains household borrowing costs, continuing pressure on living standards amid elevated food and energy prices. Future policy moves will hinge on inflation movements and economic signals over coming months.
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