The Bank of England has lowered the cost of borrowing but warned that interest rates may not fall as fast as financial markets expect.
Investors take the view that the world has changed, that the trade war President Trump has unleashed means weak economic growth is now a greater worry than high inflation.
Bank Rate has been reduced to 4.25%. Markets are pricing in up to three further cuts before the end of the year
The Bank of England is leaning into that view.
“The past few weeks have shown how unpredictable the global economy can be,” says Andrew Bailey, the Governor. He adds: “We need to stick to a gradual and careful approach to further rate cuts.”
With exquisite timing, the Bank has published its assessment of the impact of tariffs on the UK economy on the same day the government is announcing an agreement with the Trump administration to reduce them.
The Bank’s forecast makes no allowance for a UK/US deal.
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It assumes that the US government permanently imposes a 10% tax on all imported goods, that tariffs on all steel, aluminium and automotive imports continue to be levied at 25%, that imports from China are hit will tariffs of 145% (with Chinese retaliation of 123%) and that, as a result, the effective tariff rate on global imports increases from 2% to 23% – the highest level since 1909.
The Bank calculates a trade conflict on this scale knocks 0.3% off UK economic growth in three years time, as activity sags, and pulls down the headline rate of inflation by 0.2%, as commodity prices fall and goods made for the US find their way into the UK.
A trade agreement which reduces or removes taxes on UK exports to the US is obviously good news but the Bank’s analysis suggests it will be do very little to offset the “hit” to UK growth.
A ferocious trade war between the US and China – the world’s two largest economies – still rages. If global growth slows, UK growth will slow too.
And the trade policy uncertainty President Trump has created has reached levels which are completely off the scale, compared to anything we’ve seen in recent decades. This uncertainty, if it persists, damage business investment and, to a certain extent, recruitment.
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In the Bank’s view, tariffs are still likely to weigh on the UK economic growth, whatever bi-lateral agreement the government has managed to secure.
And the Bank still believes it’s too soon to decide that inflation has been tamed.
Water and energy bills rose in April. Food prices are edging up.
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Last month, the government has saddled companies with higher employment costs with higher national insurance contributions and an increase to the minimum wage.
The headline rate of annual inflation stood at 2.6% in March, the Bank believes it jumped in April before peaking at around 3.7% in September and fading thereafter.
But the Bank also notes that this mini-wave of inflation is breaking at a time when households and businesses are highly sensitive to price rises.
The upward pressure on wages and prices could increase, forcing the Bank to keep its foot on the brakes.
“Monetary policy is not on a pre-set path,” notes the Bank and “risks to inflation [remain] in both directions”.
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