- First rate decision from the Bank of England since Liberation Day looks almost certain to deliver a cut
- The uncertainty over US trade policy makes it challenging to accurately estimate economic growth
- It also muddies the inflation forecast
- Nonetheless markets think we could be in for a base rate of 3.5% by the end of the year
- Mortgage borrowers set to cash in on Trump’s trade policy
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“Donald Trump’s tariffs have caused a massive reappraisal of the future path of UK interest rates. As things stand markets are focusing on the collateral damage to the UK economy rather than the potential for a trade war to ignite inflation once again. As a result, the market is now assigning a 50% chance to the base rate being 3.5% or lower by the end of this year (Source: Refinitiv). No-one should ink that onto their calendar, because right now the ultimate shape of US trade policy, and its economic effects, are about as clear as a muddy puddle in the dead of night. Forecasts are by their nature vulnerable to correction by unfolding economic reality, and that applies in spades right now.
“The effects of trade tariffs, once imposed, are highly unpredictable, and could unleash both inflationary and deflationary forces. On the one hand, tariffs themselves increase the price of imported goods, which leads to higher inflation, other things being equal. If the UK doesn’t impose any tariffs on US goods, UK consumers will be largely sheltered from this direct inflationary effect. But there are second order effects, which may not be so benign. In particular the appreciation of the US dollar against the pound represents a risk to the price for US goods on sale in the UK, though more broadly against a basket of major currencies the dollar has actually weakened since Liberation Day.
“On the other side of the coin, deflationary forces are also at play. Expectations of a global economic slowdown have prompted a large fall in the oil price. The energy price cap is now forecast by Cornwall Insight to fall by almost 9% in July. Higher energy prices were partly behind the Bank of England’s assessment that CPI inflation would rise to 3.7% later this year, so we may well see the central bank walking back its inflation forecast to accommodate the dramatic change in outlook. We could also see US trade partners turning to the UK to offload excess exports to the UK at knock down prices, which could also put downward pressure on domestic inflation.
“Clearly the policy uncertainty from this US administration is also sky high. This isn’t just about what tariffs the US finally imposes on the UK after all the talking is done, but also the reaction of the UK, and other trade partners, to the US, and to each other. It’s a multivariate, inconstant ball of confusion. If you had to draw the possible paths for the global economy right now, it would bear a striking resemblance to Mr Messy (the character from the Roger Hargreaves books, not the footballer).
“The Bank of England also has mixed messages on the domestic inflationary front to contend with. Wage growth is a key data point watched by the Bank of England, and April’s National Insurance hike will make employers more reticent to push up wages as they deal with the extra cost, perhaps relieving some inflationary concerns. But it will also partly find its way into consumer prices, putting upward pressure on inflation. The rise in the minimum wage may also stir inflationary concerns in the longer term as calls for differentials to be maintained could shift wage growth up more broadly. The UK economy also grew by 0.5% in February alone according to the ONS, which may actually prompt the Bank of England to upgrade their 2025 growth forecast from 0.75%, depending on how damaging an impact the central bank assigns to tariffs.
“Donald Trump may not have intended to liberate UK mortgage holders from high rates, but his tariff announcements have done just that. Since Liberation Day, the swap rates which stand behind mortgage pricing have fallen decidedly below 4%, and we have seen a wave of lenders offering more competitive mortgages (see chart below). How this trend continues to play out depends on what the Bank of England does and says this week. Given the market is fully gunning for a rate cut, there is scope for the Bank of England to surprise everyone with some hawkish behaviour. That’s more likely to come from the commentary or the vote split, rather than the decision itself. However, seeing as this is the first time we have heard from the MPC as a whole since Liberation Day, there is a chance the market is misreading the room.”
Source: Bank of England OIS curve data
