The Bank of England has chosen to lower interest rates. While progress is being made in reducing inflation, there are growing concerns about potential inflation risks over the next 2-3 years. Current inflation is largely due to temporary factors. There is a chance this could lead to persistent inflation, although a weaker job market might help keep it in check.

Sustainability of Rate Cuts

There are questions about whether recent rate cuts can be maintained if pricing and wage-setting behaviors change. The Monetary Policy Committee insists that the UK’s monetary policy is still tight. Inflation in the UK remains high compared to other advanced countries and hasn’t dropped sustainably. Wage growth is still above pre-pandemic levels and is affecting inflation. Given the focus on wages, it’s clear that wage data will be key for economic analysis in the coming months. There is worry that inflation could spiral if wage growth continues, risking a tough economic downturn. It’s evident that even with the recent interest rate cut, the future isn’t certain. A key policymaker has already flagged rising inflation risks over the next couple of years, suggesting these issues may not be just temporary. This uncertainty is challenging for the market, which expected a more predictable path for rate cuts.

Focus on Wage Data

Traders should closely watch UK wage data in the upcoming weeks. Recent reports show average weekly earnings for the three months ending June 2025 at 4.9%, a level that makes the Bank of England uneasy. If wage pressures don’t ease, the threat of a wage-price spiral grows, complicating any further rate reductions. This concern is heightened by recent inflation data, with the Consumer Price Index (CPI) for July 2025 rising to 2.8%, higher than analysts had predicted. This increase comes even as the job market appears to be softening, with the unemployment rate rising to 4.5%. The conflicting signs of inflation and a weakening job market pose a challenge for monetary policy. For derivative traders, this indicates a period of heightened interest rate volatility. It would be wise to consider options that benefit from price fluctuations, such as straddles on short-sterling or SONIA futures. Such a strategy could be advantageous if the Bank suddenly pauses its rate cuts or even reverses its course. The market is already adjusting its expectations for interest rates. Current Overnight Index Swaps suggest less than two full 25 basis point cuts by the end of 2025, a significant drop from the three cuts anticipated just last month. This indicates that bets on sharp declines in UK rates are now riskier. Reflecting on 2022-2023, when central banks were caught off guard by persistent inflation and had to raise rates aggressively, the latest comments suggest the Bank of England is keen to avoid making hasty rate cuts. As a result, the criteria for continuing rate cuts are now much stricter than they were just a few weeks ago. Create your live VT Markets account and start trading now.

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