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Services PMI sharpens case for September rate cut

Journalist: John Choong (Head of Markets and Research), Newspage

ended 05. August 2024

The Monetary Policy Committee (MPC) may have started its rate-cutting cycle last week. However, the pace of cuts moving forward will be heavily dependent on one key macroeconomic piece of data — services inflation, as the metric now makes approximately 50% of the inflation basket.

Swap rates have been trading as if September's rate cut is pretty much guaranteed, but any hints that services inflation isn't cooling as quickly as projected could see yields push back up.

In both May and June, the services Consumer Price Index (CPI) came in much higher than the Bank of England (BoE) had initially estimated, at 5.7% vs 5.3%, and 5.7% vs 5.1%, respectively. As a result, the Bank revised its forecasts for services CPI for the rest of the year in its latest Monetary Policy Report. Thus, it was no surprise to see the MPC's decision to cut rates only separated by one vote.

Bank staff also upgraded their projections for headline inflation by an additional 0.1%. CPI is now only expected to peak at 2.7% later this year or early next year, hence Governor Andrew Bailey's more hawkish commentary during his press conference last week. The Governor stated that committee members weren't looking to cut rates too heavily or quickly due to services inflation being so sticky.

With July's inflation data due in less than 10 days' time, this will be a key metric to pay attention to. The central bank only sees services inflation dropping by a mere 0.1% to 5.6%. But the latest services PMI data suggest that there's a possibility that the services print could come in lower than what the BoE forecasted. According to the PMI report, services firms reported that both input and output price inflation fell to their lowest point since early 2021.

Considering the fact that these two PMI metrics have had a flawless success rate in predicting month-on-month (M/M) services inflation so far this year (with the exception of April due to annual one-time effects), the likelihood that services inflation comes in higher than 5.7% seems very unlikely. Therefore, this should bode well for the rate-cut outlook and the property market. This is especially when PAYE pay estimates showed that M/M wages declined, while the latest BoE Decision Marker Panel saw firms raising prices by 4.2% in July, down from 4.6% in May, and the lowest since September 2021.

As the bar for services inflation has been set relatively low, this gives more room for the data to undershoot the Bank's forecast in 10 days' time. Given that the odds of a September rate cut sat at 55% as of Friday, this morning's data should tip the odds more in favour of another cut next month, especially on the back of a market sell off that now sees a 60% chance that the US Federal Reserve could instigate an emergency rate cut before its next meeting in over 40 days' time.

Ultimately, however, the proof will be in the pudding(s), with two inflation releases before the MPC reconvenes in mid-September. But judging by the trajectory of wage growth, the low bar for success, as well as the dovish tilt of the MPC going into its next meeting, there's certainly room for optimism for rate cuts and the mortgage market.

6 responses from the Newspage community

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Chris Barry
Director at Thomas Legal
Last week's announcement by the MPC to reduce Bank Rate by 25bps was very much coupled with a message to hint that cuts would not be frequent or sharp. However, news over the weekend negatively impacting the financial and FX markets sent banks into shock and implies the US Federal Reserve may take emergency measures after deciding to hold rates just last week.

Positive inflation news in the UK, coupled with what appears to be potential large cuts in the US, is likely to lead to a high probability the UK could see a further 25bps reduction in September. Whilst this sounds like good news for borrowers and purchasers, my concern is whether UK banks have large positions exposing themselves to some of the global FX and equity losses which could alter their attitude to risk and may lead to the withdrawal of some higher LTV products.
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Scott Taylor-Barr
Principal Adviser at Barnsdale Financial Management
Rate cuts can be just as problematic for the property market as rate rises, which is for many people an odd thought, but the property market works best with stability. Whenever you have the chance of rate rises, or rate drops, people tend to put off making big decisions; “Let's wait and see what happens" becomes everyone's watch word. However, waiting to see what happens can be a double-edged sword, because yes, you could get a cheaper mortgage if rates fall, but it is also likely that more buyers will be attracted to the property market meaning more competition for property, which naturally increases property prices. So, whilst waiting for rates to fall could save you money on your mortgage, you could end up paying more for the property than you would of a few months earlier, negating the saving straight away.
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Riz Malik
Independent Financial Adviser at R3 Wealth
A lot can change in a few days on both sides of the pond. If the Federal Reserve initiates emergency cuts shortly after their recent meeting, combined with the lower-than-expected inflation data, we might see another rate cut in the UK sooner rather than later. This would further boost the UK property market and benefit borrowers.
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Stephen Perkins
Managing Director at Yellow Brick Mortgages
For a while, services inflation has been stuck like a spider in a bathtub. The indications that it may now come in under expectations is great news for overall inflation and the speed of future base rate cuts. With the US looking recession-bound and talk of multiple half percent cuts from the Fed, it now appears we may well get another 0.25% base rate reduction in September, which will be greatly welcomed by borrowers and businesses alike.
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Ben Perks
Managing Director at Orchard Financial Advisers
Bank of England governor, Andrew Bailey is not that bold or exciting. Last week he said, “the UK economy has been stronger in recent months, but this does add to the risk that inflation could be higher than expected if we cut rates too much and too quickly”.

He hints here at a slower road to recovery than many want, but given the slowness they showed to react to inflation, the Monetary Policy Committee is highly likely to act slowly now too. It would be nice to see a cut again this year, but I won't hold my breath.
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Elliott Culley
Director at Switch Mortgage Finance
The latest MPC meeting was a closely fought contest with a 5 to 4 vote in favour of reducing rates. If the data continues to be better than Bank of England predictions, it will make calls for a further drop stronger. There are still worries inflation may rear its head again in the winter and at this point I would imagine the Bank of England will be cautious about dropping rates again so soon.