UK Interest Rates Cut for the First Time in Over Four Years: Implications for the US and Oil Price

By Jonathan G. Browning

Chief Strategy Officer, Hornet Corporation | August 1, 2024

In a significant move, the Bank of England has cut interest rates for the first time in over four years. This decision not only impacts the UK economy but also has potential ripple effects on the US and global oil prices. Here’s an in-depth look at what this rate cut means.

UK Interest Rates Cut for the First Time in Over Four Years: Implications for the US and Oil Prices

The decision the Bank of England’s Monetary Policy Committee (MPC) voted to lower the benchmark interest rate from 5.25% to 5%, marking the first reduction since March 2020, when the COVID-19 pandemic began.

This move reflects a response to easing inflationary pressures, though it was a closely contested decision among policymakers.Andrew Bailey, the Governor of the Bank of England, highlighted the delicate balance in their decision-making. "Inflationary pressures have eased enough that we’ve been able to cut interest rates today," Bailey said. However, he cautioned against expecting a rapid decline in borrowing costs, stressing the need to maintain control over inflation.

Implications for Borrowers and Savers in the UKFor UK homeowners and those with variable-rate mortgages, the immediate effect will be a reduction in monthly payments, offering some relief from the recent surge in mortgage costs. Approximately one-third of homeowners with fixed-rate mortgages are still benefiting from rates below 3%, thanks to deals secured during a period of historically low interest rates.

However, these deals are set to expire by the end of 2026, which could lead to higher effective interest rates for many borrowers as they refinance their loans at prevailing market rates.On the flip side, savers are likely to face a decrease in returns on their deposits. This typical consequence of rate cuts will prompt many to reassess their strategies and explore alternative investment options to maintain their income levels.

The Inflation ContextThe decision to cut rates comes in the context of inflation hitting the Bank’s 2% target in May and remaining there in June. However, core inflation, which excludes volatile items such as food and fuel, remains comparatively high. The Bank of England expects inflation to rise in the year's second half as energy costs increase with the onset of colder months. Wage growth, a critical factor influencing inflation, has slowed. The Bank’s MPC continues to monitor this closely. Despite the recent public sector pay rise announced by Chancellor Rachel Reeves, the Bank does not anticipate a significant impact on inflation from this increase.

Global Impact: The US and Oil PricesThe Bank of England’s rate cut could have notable implications beyond the UK. Lower interest rates weaken the British pound, making UK exports cheaper and potentially boosting demand for commodities, including oil. This increased demand could exert upward pressure on global oil prices. For the US, a stronger dollar against a weaker pound could lead to more expensive American exports, potentially impacting trade balances. Additionally, if higher oil prices materialize, they could contribute to inflationary pressures in the US, complicating the Federal Reserve's efforts to manage inflation through its interest rate policies.

In the global oil market, higher demand driven by a weaker pound and potentially increased economic activity in the UK could lead to higher oil prices. This would impact not just the UK and US but also other economies reliant on oil imports.

Market Reactions and Economic OutlookThe reaction from financial markets has been mixed. While some investors welcomed the rate cut as necessary to support economic growth, others expressed concerns about the potential for renewed inflationary pressures if rates are cut too aggressively. The Bank’s chief economist, Huw Pill, who voted against the rate cut, echoed these concerns, highlighting the need for a balanced approach to monetary policy.

The Bank of England’s cautious stance suggests that further rate cuts are unlikely in the near term. The focus remains on ensuring that inflation stays within target levels while supporting economic stability. As global economic conditions continue to evolve, the Bank must navigate a complex landscape, balancing the needs of borrowers, savers, and the broader economy.

Jonathan G. Browning

Chief Strategy Officer, Hornet Corporation.