BOE and Fed align on interest rate cuts

In the United States (US) the Federal Open Market Committee (FOMC) unanimously voted to cut interest rates by 25 basis points (bps) to a range of 4.50% - 4.75%, marking the second consecutive cut. This is smaller than the 50bps cut in September, as higher inflation caused the FOMC to take a more measured approach.

The FOMC continue to describe gross domestic product (GDP) growth, at 2.8% in the third quarter, as “solid”. However, with inflation on the rise there is less enthusiasm for lowering interest rates.

Federal Reserve (Fed) Chair, Jerome Powell, avoided speculating on the impact of President Donald Trump’s upcoming policies, stating action will be taken if they are implemented.

Investors expect another 25bps cut to follow in December, which we believe could support equities. We expect interest rate cuts to continue in 2025.

Despite the significant developments we have seen from the Autumn Budget and the US presidential election over the past few weeks, the Bank of England (BoE), as widely anticipated, remained on track with a second 25bps cut. The base rate now stands at 4.75%, down from 5%.
The more interesting aspect of the meeting this time around was the update to the BoE’s forecasts, which gave some insight into the health of the UK economy. 

The BoE expects the combined effects of the measures announced in Autumn Budget 2024 to provisionally boost the level of GDP by around three quarters of a percent in a year’s time, relative to the August projections. The Budget could also increase Consumer Price Inflation (CPI) by just under half of a percentage point.

Recent data in the UK reflected an easing of inflation with CPI, core CPI and the often ‘sticky’ services component coming at 1.7%, 3.2% and 4.9% respectively, all lower than expected.

The BoE’s Monetary Policy Committee (MPC) forecasts inflation to rise to around 2.5%, by the end of this year from 1.7% in September.¹ It could go as high as 2.7% by the end of 2025, before falling to 2% by the end of the three-year forecast. To achieve this, and counteract the second-round effects of the Budget on prices and wages, there would need to be some spare capacity, such as un-utilised factories, in the economy.

We expect the BoE to continue to focus on the data to determine their decisions with investors now pricing in a 25bps cut each quarter in 2025.

Back in the US, annual CPI inflation in October stood at 2.6% in-line with expectations and up from 2.4% in September. Core inflation, excluding food and energy, remained at 3.3%.

Second-hand car prices rose by 2.7% in October, adding pressure for consumers, while clothing prices fell by 1.5%, keeping core goods inflation neutral for the month and negative for the past 12 months. Energy prices dropped 1% due to weaker crude oil prices, but energy services saw a strong increase. Food inflation slowed slightly, with the annual rate now at 2.1%.

The current rate of inflation is unlikely to derail the Fed’s plans to cut interest rates. We expect a 25bps cut at the final 2024 meeting this month. We remain vigilant of any further changes to inflation, but are optimistic on the US economy, given its resilience and potential expansive fiscal policies under Trump.

UK October annual headline CPI inflation was 2.3%, slightly above expectations of 2.2% and up from 1.7% in September. Core CPI inflation (excluding energy, food, alcohol, and tobacco) was 3.3%, - also slightly above expectations. 

The rise in headline CPI was driven by a 9.5% hike in Ofgem’s price cap, which came into effect on 1st October. Despite CPI inflation being above the BoE 2% target, it’s still heading down, which is good news for investors. 

Services CPI inflation stayed high at 5%. However, this could rise further in 2025 as the VAT on school fees, higher sewage prices and the vehicle excise duty increase from April feed into the economy. All goods CPI inflation was down 0.3%, narrowing from -1.4% in September as higher energy prices impacted costs.

The BoE expects inflation to peak at 2.8% by the summer of 2025 before slowing to 1.8% by the end of 2027. Despite these inflation concerns, this is unlikely to prevent the BoE from reducing interest rates.

Government bond yields have risen, reflecting the potential for the BoE to take a slower approach to cutting interest rates and increased issuance because of the extra borrowing announced in the Budget. Short-term two-year gilt yields are around 4.2% and remain attractive, given the uncertain UK economic outlook.

1. Reuters.com; Bank of England cuts rates but sees higher inflation after Reeves’ budget, 7 November 2024