Will interest rates be cut in June? The dilemma facing the Bank of England

This week, the Bank of England (BOE) released its figures on pay growth in the UK, a measure it keenly watches before deciding whether to cut interest rates. The figures showed that average annual pay increased by 6% excluding bonuses and 5.7% including bonuses. Both of which are unchanged from last month. 

Unemployment increased from 4.2% to 4.3%, meaning another 166,000 workers became unemployed compared to last year, taking the total out of work or seeking work to 1.486 million. Vacancies feel too by 26,000 to 896,000 in the three months to April. The rising unemployment figures and the number of vacancies are signs that the labour market is colling, another measure that the Bank of England has said it will be monitoring closely before deciding if it wants to start the cycle of cutting interest rates in June.  

Right, boring stuff over and onto what I think will happen in the coming months and whether interest rates will likely be cut in June. The inflation data for April is due next week, and most analysts predict (and they are often wrong) that there is a real chance that inflation could dip below 2% for the first time in over two years, mainly due to the energy price cap falling in April, below the target of the Bank of England. 

So, mostly good news, with wage growth stagnant, the labour market cooling, and inflation next week set to fall below 2%. When the BOE announced its pay growth data, it is no wonder that markets immediately started pricing in a 50% chance of a cut in June. As the table below highlights, markets are pricing in a 59% chance of an interest rate cut in June. 

Pricing date 14/05/24

But it's not quite as simple; it never is. The dilemma for BOE is not just data from within the UK but also across the Atlantic from the United States of America. Inflation in the US has been more stubborn when compared with the rest of Europe, rising to 3.5% last month, up from 3.2%, meaning that the Federal Reserve (America's equivalent of the Bank of England) will have to delay its interest rate cuts. Before this, the markets in the US had been pricing in cuts to the base rate seven times this year but are just pricing in two this year. 

What is the dilemma for the BOE then? We have different economies and different geographical borders. The answer is investors; broadly speaking, the pound strengthens when the interest rate is raised and weakens when it is cut. This is because the pound's exchange rate is determined by investors trading sums of currency.

The central bank sets the base rate in an economy—in the UK, it's the Bank of England. If the Bank of England raises the base rate, investors get more return on their money if they put it in UK banks, which encourages international traders to buy sterling and pushes up its price.

The reverse is also true. If the Bank of England cuts interest rates and other central banks don't, investors will likely dump the pound in favour of a different currency, the dollar, to get higher returns. This will worry the Bank of England: the weakening of the pound.

A weaker pound against the dollar would mean higher import prices, raising prices and adding to inflation. This would, more than anything, worry the Bank of England. 

The Fed releases its inflation figures today, and the Bank of England officials will monitor this data as closely as they will monitor inflation data next week in the UK. 

Right, it's decision time. Will the Bank of England cut interest rates in June? In short, it is highly unlikely. The monetary policy committee will be split relatively evenly in June, with those wanting to cut interest rates and those wanting to hold them, paving the way for the first interest rate cut in August. But who knows, stranger things have happened, and if there is one thing these last two or three years have taught us, we should expect the unexpected.