AXA IM: Bank of England will most likely cut rates in November

16 augustus 2024

By Gabriella Dickens, G7 Economist at AXA Investment Management

• CPI inflation edged up to 2.2% in July, from 2% in June – but that was always expected, as the drag from energy prices eased. In addition, the headline rate came in below both the consensus, 2.3%, and the Bank of England’s forecast
• 2.4%.Core inflation also fell to 3.3%, from 3.5%, consensus, 3.4%.
• These undershoots reflected a material slowdown in services CPI inflation to 5.2%, from, 5.7% (consensus 5.5% and BoE 5.6%). While a large part of the weakness was due to volatile components, such as hotel prices and airfares, underlying services measures also lost momentum.
• The headline rate will rise again over the next few months, as the sharp declines in energy prices in 2023 are not repeated. We expect inflation to end the year marginally in excess of 2.5%.
• Food, core goods and services inflation should offset some of the upside pressure.
• It will be tight, but we still think the Bank will cut the main policy rate in November; we expect a split of 5:4.

July’s CPI inflation data will be further confirmation to the MPC that things are on track. Yes, the headline rate ticked up for the first time this year to 2.2%, from 2.0%. But that was always expected as the drag from energy price inflation eased – indeed this will likely continue next month. Gas and electricity prices fell by a smaller 7.8% and 6.8% respectively in July 2024, than in July 2023, 25.3% and 8.6%, leaving energy price inflation at -20.1%, compared to around 27% over the past three months.

Nonetheless, the headline rate came in below both the consensus (2.3%) and the Bank of England’s forecast (2.4%), and the core inflation rate fell to just under a three-year low of 3.3%, from 3.5% - markets had expected a drop to 3.4%. In large part, this was due to services inflation, which came in well below expectations. Services CPI inflation fell to 5.2%, compared to the consensus (5.5%) and the Bank of England’s forecast (5.6%).

Admittedly, much of the weakness was centred in volatile categories. The sharp jump in hotel prices in June, for instance, proved temporary, almost entirely reversing with a 6.4% month-to-month drop in July compared to a 8.2% rise a year previously.

We think this in a large part reversed the Taylor Swift effect in June. Restaurant and hotel price inflation fell to 4.9% in July, from 6.3% in June, knocking 0.18 percentage points off the headline rate, as a result. Air fares also came in weaker than expected, rising by 13.3% in July 2024, compared to July 2023, 32.9%. But underlying services inflation – excluding indexed and volatile components, rents and foreign travel – also softened by around 0.4 percentage points.  

The headline rate looks set to tick up mechanically over the rest of the year, as the tailwind from energy prices continues to ease. Note services inflation will likely edge higher again in August, due to base effects and as some of the temporary weakness in July’s data rebound, before continuing downwards over the remainder of the year.

Taking a step back from the monthly volatility, though, the inflation shock of the past few years appears now to be largely controlled. We think the Bank of England will place more weight on the medium-term outlook rather than the minutia of the incoming data as fears about unanchored inflation expectation recede.

We continue to think that the MPC will push through further rate cuts at alternate meetings, alongside its latest forecasts, meaning one more 25bp cut looks likely this year in November. The key risk is the Budget that’s due to take place on October 30th; if fiscal policy is tightened more stringently than expected, as the new Chancellor is forced to make some tax changes to plug the hole in the public finances, the Bank of England will likely respond with looser monetary policy. However, we see this as more of risk for next year’s rate outlook. For now, we remain confident in our forecast for four cuts in 2025, leaving Bank Rate at 3.75% by year end.