Bank of England takes it easy on monetary easing

Summary

• The Bank of England (BoE) delivered a widely expected 25 bps policy rate cut to 4.75% at today's monetary policy announcement. The central bank's accompanying comments were mildly hawkish on balance, suggesting the U.K. central bank will continue to lower interest rates at only a gradual pace in the quarters ahead.

• The BoE projected above-target inflation over much of its forecast horizon, and relatively steady GDP growth through 2025 and 2026. The central bank also highlighted the boost to growth and the inflationary implications from the recent U.K. government budget. Altogether, BoE policymakers said “a gradual approach to removing policy restraint remains appropriate.”

• Given the overall expansionary U.K. budget, we have also nudged our U.K. GDP growth forecasts higher, to 1.7% for both 2025 and 2026. We have also revised our CPI inflation forecasts slightly higher.

• Considering our revised forecasts, recent economic data which remain encouraging overall, and still-elevated wage and price inflation, we expect the Bank of England will continue to adopt a gradual approach to monetary easing in the quarters ahead. Specifically, we forecast 25 bps policy rate cuts in February, May, August and November next year, followed by a final 25 bps rate cut in February 2026. That would see the BoE's policy rate end 2025 at 3.75%, and reach a terminal rate of 3.50% by early 2026.

Bank of England cuts interest rates, signals gradual easing to continue

The Bank of England (BoE), in a widely expected decision, lowered its policy rate by 25 bps to 4.75% at this week's monetary policy statement. However, there were mixed messages in the BoE's accompanying statement, guidance and updated economic projections, suggesting to us that the U.K. central bank will continue to lower interest rates at only a gradual pace in the quarters ahead.

BoE policymakers voted 8-1 to lower interest rates at today's meeting, with the one dissent in favor of holding rates steady at 5.00%. In opting to lower interest rates, the BoE said:

• There has been continued progress in disinflation, particularly as previous external shocks have abated, although remaining domestic inflationary pressures are resolving more slowly.

• Policymakers judged “that the labor market continues to loosen, although it appears relatively tight by historical standards.”

• Policymakers offered various scenarios for the economic outlook, and said their forecasts are based on the scenario in which a period of economic slack may be required to fully normalize pay and price-setting dynamics.

The BoE's updated economic projections sent a mildly hawkish message. The central bank upwardly revised its CPI inflation forecast for the end of 2024 to 2.7% and raised it forecast for the end of 2026 to 2.2% (both above the inflation target), while forecasting 1.8% by the end of 2027 (slightly below the inflation target). The central bank projected relatively steady U.K GDP growth of 1.5% in 2025 and 1.4% in 2026. That said, it's worth keeping in mind these projections are based off a market-implied policy rate path which is slightly lower than that which currently prevails, given that the market's rate expectation have moved higher in recent days.

Importantly, the Bank of England also highlighted the potential growth and inflationary effects of last week's U.K. government budget announcement. The BoE said the announced measures are provisionally expected to boost the level of GDP by around 0.75% at their peak in a year’s time, relative to their August projections. The Budget is provisionally expected to boost CPI inflation by just under 0.5 percentage points at the peak, reflecting both the indirect effects of the smaller margin of excess supply and direct impacts from the Budget measures.

Based on this assessment, BoE policymakers wrapped up by saying “a gradual approach to removing policy restraint remains appropriate. Monetary policy will need to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further. The Committee continues to monitor closely the risks of inflation persistence and will decide the appropriate degree of monetary policy restrictiveness at each meeting.” We see little in the central bank's guidance that would suggest an acceleration in Bank of England easing any time soon. That message was reinforced by BoE Governor Bailey, who said we “need to make sure inflation stays close to target, so we can't cut interest rates too quickly or by too much.”

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