BoE Rate Cut Hopes Overlook a Fine Recovery

Chatter around this month’s upcoming Budget is currently dominating headlines we follow, but calls for a Bank of England (BoE) rate cut seem close behind. The latter followed the latest slate of UK monthly data, which left us befuddled. In our view, Britain’s recovery from post-pandemic hot inflation and soft economic growth appears on track, rate cuts or no—and the latest data illustrate this well.^[i]

We saw the latest rate cut chatter erupt when fresh data showed UK wage growth slowed in August. Per the Office for National Statistics, average earnings excluding bonuses grew 4.9% y/y in the three months to August.^[ii] This met analysts’ expectations but marked a slowdown from May – July’s 5.1% and extended a four-month run of cooling British wage growth.^[iii] Given the BoE has long (and in our view, wrongly) cited fast wage growth as a risk to slowing inflation, commentators we follow cheered August’s reading as a harbinger of another cut next month. Ratcheting chatter we tracked up further, September CPI slowed to 1.7% y/y, below the BoE’s target.^[iv]

But in reality, we find wages follow inflation, so August’s pay-growth cooling just added late-lagging confirmation of inflation’s earlier action. Nobel laureate Milton Friedman showed this back in the 1960s, teaching that businesses compete for new labour using real (inflation-adjusted) wages, not nominal. As inflation slows, nominal wage growth follows because businesses needn’t offer as high a premium. Far from being a driver of future price rises, in our view, wage growth’s remaining above the inflation rate shows consumers gradually regaining the purchasing power they lost to rising prices.

Exhibit 1 shows how this has unfolded in the UK. Inflation spiked first, then wages started catching up. Now, inflation has continued slowing despite higher wage growth—society is beginning what we find is the normal route to overcoming hot inflation.

Exhibit 1: UK Wage Growth Follows Inflation

Source: Bank of England, as of 21/10/2024. UK average weekly earnings excluding bonuses (rolling 3-month average) and CPI, year-over-year changes, December 2020 – September 2024. September wage data have not been released yet.

As for the BoE’s November meeting, far be it from us to predict what they will do. Maybe they cut again, maybe not. But we are continuously seeing evidence it doesn’t matter much either way is rolling in. Like monthly gross domestic product (GDP, a government-produced measure of economic output) which grew 0.2% m/m in August, reaccelerating after flat readings in July and June.^[v] The growth was broad-based, with all three sectors—services, production and construction—registering expansion.^[vi] Still, publications we follow insist growth is slowing after Q1 and Q2 GDP grew 0.7% and 0.5%, respectively.^[vii] Perhaps, but we don’t think it is a given. Monthly GDP has fluctuated all year, and Q1 and Q2 had their own weak patches.^[viii] Moreover, if UK GDP managed to bounce high and fast from late-2023’s contraction without rate cuts, then we doubt sustained growth hinges on the BoE now.^[ix]

Elsewhere, S&P Global’s Services and Manufacturing purchasing managers’ indexes (PMIs, monthly surveys that track the breadth of economic activity) remained in expansion in September and October, and September retail sales jumped 0.3% m/m, defying calls for a -0.3% fall.^[x] All of these growthy data come with just one rate cut so far, in August.^[xi] Might another help bolster the economy and markets? Perhaps, but our research suggests it wouldn’t move the needle the way we have seen touted in headlines. Some commentators we follow suggest it could boost M4 money supply and business lending, but those resumed growing in late 2023, well before the BoE’s first cut.^[xii] We think there are plenty of signs the UK was already in recovery mode.

Whilst our research suggests UK stocks’ economic driver looks bright, this isn’t the only factor affecting markets, in our view. UK stocks have trended flattish, even down a bit for almost half a year now, with political and fiscal uncertainty likely playing a role ahead of next week’s highly anticipated Budget.^[xiii] But as the fog lifts, we think UK stocks’ economic support still looks strong, regardless of the BoE’s policy decision next month.