At its latest meeting, the Monetary Policy Committee (MPC) chose to hold the Bank Rate steady at 5%. While inflation has retreated towards the Bank’s target levels, economic growth has stalled, and key sectors are exhibiting signs of weakness. Given these developments, it is worth examining whether maintaining the current interest rate is the optimal approach or if a faster reduction might better serve the economy’s needs.
Economic Stagnation
The latest GDP figures paint a concerning picture. The economy registered zero growth in both June and July 2024, with the three-month growth to July at a tepid 0.5%. This stagnation is not merely a statistical blip but reflects underlying weaknesses across several sectors. Manufacturing output declined by 1.0% in July, with significant contractions in transport equipment and machinery—industries that are typically bellwethers for economic vitality. The construction sector also contracted by 0.4%, signalling reduced investment and confidence.
Business surveys corroborate this slowdown. Investment intentions have softened, and consumer confidence remains fragile. The plateauing of economic activity suggests that aggregate demand is insufficient to propel the economy forward. In such a context, maintaining a restrictive monetary policy could exacerbate the slowdown. Lowering interest rates could provide the necessary stimulus to reignite growth by reducing borrowing costs, encouraging investment, and bolstering consumer spending.
Inflation
Inflation has historically been the primary concern dictating interest rate policy. However, recent data indicates that inflationary pressures are easing. The Consumer Prices Index (CPI) inflation rate has fallen to 2.2% in August 2024, aligning with the Bank’s target. Core inflation remains moderate at 3.6%, and notably, goods inflation has turned negative at -0.9%.
This downward trajectory in inflation is underpinned by several factors. Global commodity prices have softened, with oil prices declining by approximately 6%. Supply chain disruptions that previously exerted upward pressure on prices have largely dissipated. Additionally, producer input costs have stabilised, suggesting that upstream inflationary pressures are waning.
Monetary policy operates with a lag, and the effects of previous rate hikes are still permeating through the economy. Persisting with high interest rates risks overcorrecting, potentially pushing inflation below target and entrenching low inflation expectations. Given that inflation is retreating organically, there is scope for the Bank to recalibrate its policy stance to support growth without undermining price stability.
Labour Market
A critical factor in assessing inflationary risks is the state of the labour market. Wage growth can fuel inflation if it outpaces productivity gains. Recent data indicates that the labour market is loosening. Private sector regular average weekly earnings growth has moderated to 4.9% from 5.3%, and vacancies have been declining gradually. Recruitment difficulties are easing, suggesting that labour demand and supply are rebalancing.
The moderation in wage growth diminishes the risk of a wage-price spiral. As wage pressures abate, the likelihood of sustained inflation from this channel reduces.
Labour market indicators also reflect underlying economic conditions. The easing of labour market tightness aligns with the observed economic slowdown. In this context, supporting employment and preventing a deterioration in labour market conditions become priorities. A reduction in interest rates could alleviate cost pressures on businesses, enabling them to maintain staffing levels and invest in workforce development.
Global Economy
economic conditions have a significant impact on domestic performance. Currently, there are signs of weakening global demand. China’s growth is slowing, and the Eurozone is grappling with its own economic challenges. Oil prices have fallen, reflecting lower global demand, and there is increased volatility in international markets.
These external headwinds pose risks to the UK’s export sector and could dampen business investment due to heightened uncertainty. In such an environment, domestic demand becomes a critical driver of growth. Monetary policy can play a pivotal role in stimulating domestic consumption and investment to offset external weaknesses.
Furthermore, other major central banks are adjusting their monetary policies in response to global conditions. The European Central Bank has recently reduced its policy rates, and the Federal Reserve this week announced their first cut in four years. In the aftermath of the Bank of England’s announcement to keep rates at 5%, sterling hit a two and a half year high against the dollar, making UK exports less competitive and exacerbating the impact of global headwinds.
Balancing Act
Critics might argue that lowering interest rates could reignite inflation or encourage excessive borrowing. However, with inflation close to target and credit growth subdued, these risks appear manageable. Household debt levels have been stabilising, and there is little evidence of credit-fuelled asset bubbles.
Moreover, the benefits of supporting economic growth at this juncture outweigh the potential downsides. The cost of inaction could be a protracted period of low growth or even recession, with long-term scarring effects on the economy. By contrast, a measured reduction in interest rates could provide a timely boost, enhancing business confidence and encouraging consumer spending.
Monetary policy should be forward-looking and responsive. Clinging to a restrictive stance when indicators suggest a need for support could hinder the economy’s recovery and undermine long-term prospects. By contrast, a proactive approach that carefully balances the risks can foster a more resilient and dynamic economic environment.
The Bank of England has a mandate to achieve price stability while supporting the government’s economic objectives, including growth and employment. Current conditions offer an opportunity to align monetary policy more closely with these goals. It is, therefore, timely for policymakers to re-evaluate the interest rate trajectory and consider a faster reduction path to stimulate the economy.