Michael Saunders, senior economic advisor at Oxford Economics and former member of the Bank of England's Monetary Policy Committee, discusses the central bank's latest rate cut to 4%.

London

The Bank of England's recent vote on interest rates was closely split due to conflicting economic signals. While economic growth remains weak and unemployment is rising, inflation is still above the central bank's target and is expected to increase further in the near term. Some members of the Monetary Policy Committee (MPC) prioritized the weak growth as a sign that inflation could fall next year, while others were concerned that high inflation could become entrenched, especially if pay growth remains strong.

The economist interviewed noted that while there is a case for a larger rate cut due to labor market weakness, the risk of fueling inflation expectations led to a more cautious approach. Additional cost pressures from higher national insurance contributions and the national living wage are keeping services inflation elevated. The economist expects the Bank of England to continue cutting rates gradually, particularly as fiscal policy may tighten with potential tax increases, further weighing on growth.

Explained: Why the Bank of England vote was split

It really shows the disparity between what's happening to economic growth and inflation. Growth is sluggish, unemployment's rising, vacancies are falling, all of that would normally point to lower interest rates, but at the same time, inflation is well above target and likely to rise further in the next few months, and so some on the MPC put more emphasis on weakness in growth as a sign that inflation is likely to fall back next year. Others worry that above target inflation this year will lift inflation expectations, keep pay growth high, and thereby limit the extent to which inflation falls next year. That's really the heart of the divide between the two parts of the committee. It's a difficult economic situation, so the vote is close. In terms of the ultimate vote that got the decision over the line, Taylor had originally voted for a 50 basis point cut and then joined the 25 basis point camp. Is there a strong case for a 50 basis point cut at a time when the Bank of England is now forecasting inflation to rise to 4% in just about a month's time? There is a case. Personally, I don't think it's a strong one. The case for a 50 is the weakness of the labor market, with the jobless rate rising fairly steadily and likely to rise further. I think the risk of a 50 is that at a time when inflation is well above target, inflation expectations will become more entrenched, and that would probably feed through to pay deals next year. Personally, I wouldn't have voted for 50 if I was on the committee. I would have voted for 25. So, Michael, the Bank of England were confident in cutting this time when it comes to rates, and they cited disinflation, the progress that they've seen there, particularly on the reduction in wage growth, and they expect that a slower labor market will feed into those prices. How confident are you about that? I do think you will get feed through of slower pay growth onto inflation and services inflation, but it won't be quick. Part of the issue here, really, is that firms are facing extra cost pressures from the big increases in national insurance contributions and the national living wage, and that's keeping consumer services inflation high despite slowing pay growth. Now, those effects actually may become more apparent in the next few months. I think we'll see services inflation stuck around 5 percent, well above a target consistent pace, even while pay growth slows further. Those effects ultimately should be temporary. They will fade during next year, but they're not going to fade quickly, so they'll get differing messages from pay and prices. Interesting, because the Bank of England said that they see inflation rising to 4 percent in September, so well off the target. That's the kind of levels that you could really see businesses passing on those costs to consumers. So at these levels, 4 percent, for instance, are you concerned that inflation is going to become embedded? There's a risk of that, but I think most likely the weakness of the economy will take care of those risks that inflation might be persistent. I think what's likely to happen over the next few months is that growth will remain sluggish, softer than the Bank of England have been expecting, and that will prompt them to cut interest rates further. But they're not going to cut rates quickly, cognizant of those worries of high inflation which you referenced. Michael, probably worth pointing out, the single mandate here of price stability for the central bank, so laser-focused on an inflation level, is there anything forthcoming from Chancellor Rachel Reeves that you think could have an impact on price stability impacting the central bank's decision-making from here? Well, yes, and this is one of the factors that is going to be affecting monthly policy in the next few months. I think it's likely that the budget late this year will include further tax rises in order to try to get the public finances back onto a sustainable path. That will weigh on growth next year. It's an extra reason why growth is likely to undershoot the Bank of England's forecasts, and that will allow the Bank of England to go on cutting interest rates. I think they'll cut rates again before the end of this year. Most likely November, could be December.

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