BoE cuts interest rates, but loosening cycle will be gradual and shallow

The Monetary Policy Committee (MPC) started its policy easing cycle today, bringing interest rates down from 5.25% to 5%, but we don’t expect the committee to be in a rush to make further cuts. 

Headline inflation is likely to start ticking up over the rest of this year as the impact from lower energy prices wears off and nominal wage growth will remain faster than the MPC would like. We are expecting one more 25 basis point cut this year probably in November. We are currently expecting four cuts in 2025, but that will partly depend on the degree of tax rises and additional borrowing announced in the budget.

Interest rate cut with caveats  

While the MPC has started its policy easing cycle, which is good news for consumers and mortgage holders, it'll probably be November before we get another cut for three key reasons. 

First, the vote was as close as it could be, with four of the nine committee members voting to keep rates on hold verses five voting to cut. And even for those members that voted to cut, the decision was ‘finely balanced’. 

Second, Bank Governor, Andrew Bailey, said the committee is cautious about cutting ‘too quickly or by too much’. And the minutes to the meeting emphasised that at 5% interest rates are still well into restrictive territory and will stay there for ‘sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term had dissipated further’. 

Third, even though the latest inflation forecasts show it undershooting the 2% target in two and three years time, if interest rates follow the path implied by markets, and by miles if interest rates are left at 5%, the committee emphasised that ‘there was a risk that inflationary pressures from second-round effects would prove more enduring in the medium term’.

What next? 

The MPC has made it clear that it intends to tread carefully when it comes to reducing interest rates over the next year. Key phrases such as the decision was ‘finely balanced’ and being cautious about ‘cutting too quickly or by too much’ suggest that the MPC feels no rush to reduce interest rates below 5%. 

It will want to see more evidence the disinflationary trend in the economy remains intact before cutting rates again. That means lower services inflation and slower wage growth. 

We think the next opportunity for a rate cut will come in November. By then it should be clear in the data that the threat of sticky inflation is receding. 

However, there is the risk factor of the Autumn Budget. Earlier in the week, the Chancellor of the Exchequer, Rachel Reeves, announced she would be borrowing £16.4bn more to boost spending on public services. That probably won’t be enough to upset any plans to cut interest rates as tax rises are likely to happen in the budget, which will offset some of the inflationary impact of the additional borrowing. 

Overall, the policy easing cycle has begun, but it will continue only gradually and only as long as the inflation and wage data continue to show progress is being made. We expect interest rates to finish the year at 4.75% and end 2025 at 3.75%. 

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