UK reaction: Cautious cut, one more likely this year

The Bank of England narrowly voted to cut Bank Rate by 25bp to 5% at today’s meeting, with five of the nine members in favour of reducing the key policy rate – Governor Bailey, Deputy Governor Lombardelli and Sarah Breeden joined Ramsden and Dhingra in voting for a cut, while the Chief Economist Pill, Mann, Greene and Haskel continued to favour no change – in line with the market consensus. The members that favoured a cut noted “some progress” in reducing the risks of persistence in inflation which made it appropriate to “slightly” reduce the degree of policy restriction. Note, though, that for some the decision remained finely balanced. Those that favoured no change, meanwhile, continued to highlight the fact that domestic inflationary pressures seemed “more entrenched” with the risk that this reflected structural factors, such as changes to the natural rate of unemployment, potential growth and r*.

On balance, the MPC was keen to avoid committing to a future path for rates, stating it would "decide the appropriate degree of monetary policy restrictiveness at each meeting", though we think a September move was effectively ruled out by the MPC with the phrase “we need to make sure inflation stays low, and be careful not to cut interest rates too quickly or by too much”.

The MPC’s new inflation forecasts, however, suggest further cuts are on the cards both this year and next. Indeed, the modal CPI inflation forecast was revised down to 1.7% in two years’ time – it had been estimated at 1.9% in May – and to 1.5% in three years’ time – from 1.6%, conditioned on Bank Rate falling to 4.87% end-24 and 4.09% end-25. A much sharper decline to 1.1% and 0.8%, respectively, is expected if Bank Rate remains at 5.00%. It is impossible to be concise, but the latest forecasts point at least one more rate cut over the next 12 months than markets had priced in at the time.  

We look for one further cut this year in November, leaving Bank Rate at 4.75% by year end. Note, though, that some uncertainty remains around who will replace Hawk Jonathan Haskel on the Committee, given it is his last meeting. A more dovish replacement could tilt the balance towards additional cuts this year.  

More broadly, the MPC appears to be pivoting away from focussing primarily on the incoming data, with Bailey stating in the Press Conference that the Bank should “not adjust its course with every data surprise”. Instead, the Governor emphasized a broad framework which the Committee would use to monitor the risks around whether the decline in persistence is “baked in, needs a period of slack or needs tighter for longer policy”. Some weight was applied to the latter scenario with the Bank’s mean forecast for CPI inflation coming in above the modal measure and with some upward skew reintroduced around its two- and three-year ahead forecasts.

The new government’s first Budget, meanwhile – which is due to take place on October 30^th – may throw a spanner in the works. Chancellor Rachel Reeves has already announced above-inflation public sector pay increases for teachers and NHS staff and a 22% increase over the next two years for junior doctors is likely to be confirmed. Note, though, that Governor Bailey stated the Bank’s initial assessment is that these pay rises will have little impact on headline inflation and that the MPC focusses mainly on private sector pay increases, as it directly impacts CPI inflation. More broadly, the new government will have to decide how to fund these pay increases, alongside plugging the gap that has emerged in the public finances. And given how strained the public purse is, we think additional fiscal tightening in the form of tax hikes is likely. The Bank of England will, therefore, be pushed to loosen monetary policy in 2025 to offset more stringent fiscal policy. We continue to look for a cut per quarter in 2025, leaving Bank Rate at 3.75% by year end.