The Bank of England should ignore politics and cut rates on Thursday

The Bank of England risks becoming public enemy number one again this week. On Thursday the Bank’s Monetary Policy Committee will announce its latest decision on interest rates. If it surprises the markets by cutting rates just two weeks before election day, some will accuse it of trying to do the Conservatives a favour.

On the other hand, if it waits, despite better news on inflation and worse news on growth, others will leap to the conclusion that the Bank is biased towards Labour. Either accusation would be grossly unfair. But how will the MPC navigate its way through this political minefield?

As a starting point, the MPC has never changed interest rates at the meeting immediately before a general election. However, there have only been six general elections since the Bank was granted the independence to set rates in May 1997, and interest rates were not changed at all over most of this period.

There is certainly no rule against individual MPC members voting to change rates during an election campaign. Sushil Wadhwani voted to hike rates in June 2001 and Sir Andrew Large did the same in April 2005. Perhaps the most interesting precedent is November 2019, when two members who had previously voted for no change switched to a cut – Jonathan Haskel (who is still on the MPC) and Michael Saunders.

We can safely conclude that the two current members who are already voting for a cut – Swati Dhingra and Dave Ramsden – will do so again this week. The question then is whether three or more of the remaining seven members are ready to join them, forming a 5-4 majority to reduce rates.

There are some good reasons why the Bank of England might be justified in waiting a little longer.

UK inflation has been relatively stubborn, notably the “core” measure (excluding food and energy) and inflation in the services sector. Forward-looking surveys of business activity and consumer confidence are encouraging, and the broad money and credit aggregates are looking healthier.

It is therefore perfectly reasonable (and desirable) for the MPC to have a range of opinions here. Some prominent former members have been calling for a rate cut for many months, notably the Bank’s former chief economist Andy Haldane. But others have argued for caution, including Andrew Sentance. These experts are neither fools nor knaves.

For what it is worth, my own view is that the new information in the past week has strengthened the case for a cut on Thursday. The economy failed to grow at all in April. Hopefully activity was only dampened by the wet weather, but this was a poor start to the second quarter.

The labour market is also continuing to cool, with unemployment ticking higher and early evidence for May suggesting that pay pressures are now easing after the jump in April.

In the meantime, the results of the Bank’s own surveys should reassure those still worried about a “wage-price spiral”.

Earlier this month the Bank’s Decision Maker Panel reported that businesses’ expectations for wage growth over the coming year fell back to 4.1pc in May, from 4.6pc in April.

We can now add the Bank’s quarterly survey of the public’s expectations of inflation over the next 12 months. The average forecast has fallen to 2.8pc, down from 3pc in February. This is well below the peak of 4.9pc in August 2022 and back in line with the 2000-21 average.

The deciding factor could be the inflation data for May. Handily, this will be released to the public on Wednesday morning, which is the day that the MPC makes its decision.

The headline measure fell a little less than expected in April, to 2.3pc, prompting markets to push back their expectations for the timing of the first interest rate cut.

Indeed, all but two of 65 economists recently surveyed by Reuters expected the Bank to wait until August, with the two outliers going for September.

But there is a good chance that the May numbers will show inflation is finally back to the 2pc target, or even lower. This would of course make it much easier for the Bank to cut rates this week, especially if the core and services measures are sharply lower too.

The balance could therefore still shift in favour of an early cut. This would not be hugely risky. A reduction of a quarter point would leave UK interest rates at 5pc, which would be some way above a “neutral” level. Combined with the Bank’s relatively aggressive sales of government bonds – the controversial policy known as quantitative tightening – this would continue to bear down on inflation.

Moreover, the Bank’s own forecasts have inflation dropping to the 2pc target and remaining there or thereabouts over the next couple of years, even on the basis of market expectations of a string of rate cuts.

The improvements in business and consumer confidence are also based on hopes that lower inflation will allow interest rates to be cut. If the Bank of England fails to deliver soon, the recovery could still be snuffed out.

Consistent with this, the latest survey from the Royal Institution of Chartered Surveyors found that the recovery in the UK housing market is starting to falter again, as expectations for rate cuts have faded.

These factors should trump any concerns about the political optics. But in any event, the latest opinion polls hardly suggest that this is a cliff-edge election where the latest interest rate decision could tip the outcome either way.

If there is enough new information to justify cutting interest rates – and if this would not completely blindside the markets – then this is what the MPC should do. Fingers crossed for a pleasant surprise.

Julian Jessop (@julianhjessop) is an independent economist. Jeremy Warner is away