The Bank of England’s decision to maintain Bank Base Rate (BBR) at 3.75% may not have generated the excitement that often accompanies a rate rise or cut, but it should certainly be viewed as a significant outcome and result.
In fact, after a number of months of economic uncertainty, geopolitical tension and market volatility, there is a strong argument to suggest stability itself has become one of the most valuable policy tools available to the Monetary Policy Committee (MPC).
A MORE COMFORTABLE HOLD?
The June decision was reached by a 7-2 majority, with only Megan Greene and Huw Pill voting for a quarter-point increase. On the surface, that may suggest the Committee has become slightly more concerned about inflation since the last vote.
However, the minutes reveal a majority that is actually more comfortable with holding rates than it was two months ago.
The primary reason for that confidence is the inflation data itself. Consumer Price Index inflation remained at 2.8% in May, significantly below the Bank’s previous expectations and down from 3.3% in March.
While inflation is still expected to rise later this year as higher energy costs continue to feed through into the economy, the Bank has revised down its forecast peak. At the last meeting, inflation was expected to reach around 3.6%; the latest assessment now suggests it will peak at just over 3.25%.
That may seem like a modest revision, but it is an important signal. It suggests the inflationary impact of the conflict in the Middle East and higher energy prices has so far been less severe than feared. Lower food price inflation and softer underlying price pressures have offset much of the anticipated increase.
Perhaps more importantly, several MPC members noted that, without the recent energy shock, inflation would already be very close to the Bank’s 2% target.
THE ECONOMY CONTINUES TO SOFTEN
Alongside this inflation picture, the minutes paint a picture of an economy that remains subdued. Demand is still weak, business confidence remains fragile and household sentiment continues to be negative. Wage growth is slowing, vacancies are falling and the labour market is gradually loosening. While headline GDP growth has been relatively resilient, the Bank believes the underlying pace of growth remains modest.
This matters because it reduces the likelihood that higher energy prices become embedded in the wider economy through wage demands and business pricing decisions. The majority of the Committee continues to believe emerging economic slack will help limit these so-called second-round inflation effects.
That does not mean the risks have disappeared. The MPC remains alert to the possibility inflation expectations could become more sensitive following several years of elevated inflation. However, the majority view is there is not yet sufficient evidence to justify further tightening.
THE MORTGAGE MARKET HAS ALREADY ABSORBED MUCH OF THE SHOCK
One of the most striking elements of these latest minutes is the extent to which the MPC acknowledges financial conditions have tightened significantly without any change to BBR itself.
Since the conflict in the Middle East began, market expectations have shifted sharply. Swap rates and overnight index swap markets moved higher as investors priced out the BBR cuts that many had expected at the start of the year. The result was a rapid increase in borrowing costs across the economy, including mortgage rates.
The Bank notes there has been full and fast pass-through from higher market rates into lending costs, with two-year fixed-rate mortgages sitting materially above their pre-conflict levels. Even with a recent shift downwards in mortgage rates from a growing number of lenders, there is still plenty to be concerned about.
This reinforces a point advisers have understood for some time. While BBR remains important, it is not the sole driver of mortgage pricing. Funding costs, swap rates and market sentiment often have a more immediate impact on the products available to borrowers. In many respects, mortgage customers have already felt the effects of tighter monetary conditions, even though BBR has remained unchanged.
WHY STABILITY MATTERS
It is also easy to overlook the significance of BBR having remained at 3.75% since December. Since then it has been nothing short of a rollercoaster both economically and within the mortgage market.
Against that backdrop, the MPC has consistently maintained its position. For advisers and their clients, that consistency provides a degree of certainty that should not be underestimated. While nobody can predict exactly how swap rates will behave over the coming months, as mentioned above, there has been encouraging progress in the mortgage market itself. Lenders have been reducing rates in recent weeks, competition has increased and product availability has improved.
The latest MPC decision therefore supports a more stable environment at a time when stability is badly needed. For borrowers approaching the end of existing fixed-rate deals and for advisers helping clients navigate a complex market, that is welcome news.
The majority of MPC members appear to have recognised policy is already restrictive, inflation is moving broadly in the right direction and mortgage borrowers have already absorbed much of the recent market turbulence. In a year defined by uncertainty, maintaining that stability may prove to be one of the most important decisions it has made.
