Bank of England's cautious tone questioned as calls for aggressive rate cuts grow louder

According to the Zhitong Finance and Economics APP, the Bank of England will announce its interest rate decision on September 19 (Thursday). Despite the central bank seemingly ignoring doubts and sticking to its exploratory rate-cutting policy, more and more investors believe that it is necessary to take more aggressive actions.

Currently, the market generally expects Bank of England Governor Bailey and his colleagues to postpone another rate cut on Thursday. However, fund managers from Abrdn Investment Management Ltd., Aviva Investors, and Allianz Global Investors are betting that this caution will not last long amid slowing economic growth and increased budget tax hikes.

Strategists from investment banks such as Goldman Sachs, HSBC, and UBS also agree with this view, believing that officials will soon be forced to intensify their response as the momentum of UK economic growth continues to weaken.

However, due to economists' expectations that this week's data will show a resurgence in service sector inflation, cautious policymakers are unlikely to change their stance - even after the European Central Bank lowered borrowing costs for the second time last week, while the Federal Reserve is expected to cut borrowing costs for the first time on Wednesday.

The market currently expects the Bank of England to keep rates unchanged on September 19 and cut rates by 25 basis points in November and December respectively. Bhanu Baweja, Chief Strategist at UBS in London, believes that it is only a matter of time before UK officials stop hesitating and make a more urgent response to the economic risks they face.

"I think at this point, a tightening monetary policy will have a quicker impact than in Europe, and certainly elsewhere like the United States," he said.

The Bank of England did signal further rate cuts in August when it announced its first rate cut in over four years to 5%. However, it insisted it would not rush to cut rates as there was no threat of an economic recession or a surge in unemployment.

On the contrary, the Monetary Policy Committee stated that in the face of persistent inflationary pressures, it would proceed cautiously and make decisions on a "meeting-by-meeting" basis.

Dan Hanson and Ana Andrade of Bloomberg Economics said, "The Bank of England may keep rates unchanged at the September meeting, indicating that it is not yet convinced that inflation has been defeated and is willing to adopt a cautious easing policy."

The market expects that by early 2026, the Bank of England will cut rates by 25 basis points seven times, eventually reaching 3.25%.

The current market consensus is that the Bank of England's actions will be slower than those of the Federal Reserve and the European Central Bank, which has already led to higher borrowing costs in the UK compared to other countries.

George Buckley, Chief European Economist at Nomura Securities, believes that the Bank of England will only cut rates once per quarter, with the next rate cut expected in November. He and many of his peers believe that officials will not change their guidance this week The cautious reason for this is the uncertain outlook for consumer price growth.

Economists predict that data to be released on Wednesday will show that the August service sector inflation rate has surged to 5.6%. The Bank of England estimates that the current overall index of 2.2% will rise to 2.7% by December.

The wage growth rate in the UK remains above the 2% inflation target at 5.1%, with data released last week indicating a strengthening labor market.

However, the view that continued rising UK consumer prices will eventually hinder monetary easing does not convince Daniela Russell, head of interest rate strategy at HSBC UK.

"We will question this explanation," she wrote in a report, "If the labor market continues to be as loose as before, the Bank of England may tolerate inflation slowly returning to target levels, and therefore cut interest rates more significantly than expected."

Last week's release of Gross Domestic Product (GDP) data may support this view. The data shows that the economy stagnated in July, meaning that in the past four months of data, the UK has not grown in three months.

Harriet Ballard, multi-asset investment manager at Aviva, said, "If the Bank of England delays easing policy, the economy will clearly slow down, indicating that interest rate cuts will be faster and deeper in the future. We still believe that the UK economy faces risks as household consumption remains weak, mortgage servicing costs may rise, and the labor market is cooling."

Analysts at Goldman Sachs, including Chief European Economist Sven Jari Stehn, said in a report last week that they expect the Bank of England to start cutting rates continuously from November, rather than cutting rates every other meeting, eventually lowering the benchmark rate to 3%. Baweja from UBS also has a similar terminal rate forecast.

More and more investors are starting to think this way. UK government bonds rose this month, outperforming their eurozone counterparts, as the market sees a greater likelihood of the Bank of England cutting rates twice more this year.

The yield on the policy-sensitive two-year government bond fell more than 30 basis points to 3.80%. The market has fully priced in a 25 basis point rate cut in November, with the likelihood of another rate cut in December rising from 50% at the beginning of the month to over 90% now.

UBS stated that its bullish forecast for two-year UK government bonds has been one of the hottest trades in recent months.

Abrdn stated last month that due to inaccurate market expectations for UK monetary policy, it has "significantly" increased its holdings of UK government bonds relative to European and US government bonds. Aviva is bullish, while companies like Federated Hermes are also considering increasing their holdings.

In addition to the deteriorating economic backdrop, investors are also encouraged by the prospect of UK Chancellor of the Exchequer Rishi Sunak potentially raising taxes in the October 30 budget as he tries to fill a £220 billion ($289 billion) public finance black hole This will mean fiscal tightening.

Orla Garvey, Senior Fixed Income Portfolio Manager at Federated Hermes, said, "We will get a budget at the end of October that is essentially a tightening budget. We have not fully reflected what I think will be an economic slowdown that we will face."