It’s all but guaranteed that the Bank of England (BoE) will hold interest rates at 4% at its meeting on Thursday. The Monetary Policy Committee (MPC) will stick to its gradual and careful guidance as it continues to try to balance rising inflation with a weakening labour market. We expect a 7-2 vote split, as two members opt for a cut.

Looking ahead, we think the BoE will keep interest rates on hold until February. We also think the BoE will slow its quantitative tightening (QT) – the pace at which the BoE reduces its gilt/bond holdings – to around £70bn next year to ease pressure on UK gilt yields, which are at record levels.

UK inflation concerns outweigh labour market weakness

The minutes of the last MPC meeting had a decidedly hawkish flavour to them, despite the majority of the committee voting to cut interest rates. Recent data has largely reinforced that tone.

The economy grew 0.3% in Q2, which was above the BoE’s forecast of 0.1%. Inflation, at 3.8%, matched the MPC’s forecast for July and will probably reach 4% in September. Evidence suggests this is the level at which households really start to pay more attention to inflation, which risks further de-anchoring inflation expectations.

We also think the labour market has recently shown signs of stabilising, albeit weakly. Indeed, payrolls only fell by 8,000 in July and that estimate is likely to be revised up.

Additionally, we expect next week’s data releases on retail sales and unemployment to show sticky inflation and a further stabilisation in the jobs market. Altogether, recent data has strengthened the hawks’ case that disinflation is slowing and that rates need to remain restrictive into next year.

However, the doves will have enough ammunition to argue for a rate cut. Payrolls suggest the labour market has shed around 120,000 jobs this year, which has helped pay growth (average weekly earnings) fall to 4.6% in June from 5.7% at the start of the year. The weakness in pay growth was a key reason for the MPC’s last cut. Indeed, Governor Bailey stated that “the one thing that is apparent is that pay has come in lower than we thought it would”.

What’s more, almost all the employment surveys are still pointing to a depressed labour market and slowing pay growth. The BoE’s own surveys suggest employment intentions fell to the lowest level since 2020 and that pay growth would drop to 3.5% over the next year.

Ultimately, we think the hawks have the upper hand in this meeting and pencil in a 7-2 vote split in favour of a hold. Financial markets agree, pricing in just a 1% chance of a rate cut. We also expect the MPC to stick to its “gradual and careful” guidance, with the pace of future cuts ultimately being determined by how quickly inflationary pressures are easing. Indeed, Governor of the Bank of England, Andrew Bailey, who previously voted for a cut in August, has questioned the future pace of rate cuts, stating there is “now considerably more doubt about exactly when and how quickly we can make those further steps”.

UK interest rates on hold until next year

Looking further ahead, we think the MPC will have to keep interest rates on hold for the rest of the year for three reasons.

First, inflation will remain close to 4% for the rest of 2025, marking the fifth consecutive year of above-target inflation. This raises the risk of households bargaining for bigger pay rises to protect their real incomes, which could contribute to further inflation persistence.

Second, economic growth was stronger than expected in the first half of the year. The UK economy grew almost twice as quickly as the US and eurozone. While we expect growth to slow in the second half of this year, it’s unlikely that growth will be weak enough to materially weigh on inflation.

Third, and perhaps most crucially, interest rates are approaching neutral. In a recent report, Deputy Governor for Monetary Policy at the Bank of England, Clare Lombardelli, recently said: “Looking at history, it’s plausible that neutral may be closer to the upper end of the 2–4% range from Bank analysis”. If neutral is close to 4%, then further reductions in rates could mean monetary policy may not be restrictive enough to return inflation to 2%.

All told, we think the MPC will have to keep rates on hold for the rest of the year to ensure inflation returns to target in the medium-term. However, there are clearly two downside risks that could precipitate a rate cut later this year.

First, despite early signs of stabilisation in the official data, surveys are still pointing to a further weakening in the jobs market. If the official data start to look more like the survey data, then the resulting rise in unemployment and slowdown in pay growth could give the MPC cover for another rate cut.

Second, Chancellor Rachel Reeves looks likely to need to raise upwards of £20bn in taxes at the Autumn Budget. How she does that could make a difference to the MPC. Near-term tax rises would dampen demand and inflationary pressures, potentially allowing more rate cuts. However, if the Chancellor opts for delayed tax rises or another round of stagflationary measures, such as duties and VAT, then the chances of a rate cut later this year would diminish sharply.

Ultimately, we think the next opportunity for a rate cut will come in February when inflation will have dropped closer to 3% and the unemployment rate will be around 5%. Looking beyond that, we think rates will settle at 3.5%.

QT to slow as BoE worries about long-term yields

At its September meeting, the BoE will decide on the pace of QT for the year ahead as it continues to shrink its balance sheet. We think the BoE will slow the pace of QT for two reasons.

First, the BoE has acknowledged that QT is pushing up gilt yields by more than previously estimated. Given the pressure on long-term yields, this builds a case for the BoE to slow QT and skew active sales towards shorter-term bonds.

Second, the BoE estimates that its preferred minimum range of reserves is between £385–530bn. Given the uncertainty around this estimate, and that the BoE’s reserves are currently around £670bn, it will want to slow the pace of QT as it reaches its preferred range to avoid putting unwanted pressure on money markets. We think the BoE will slow the pace of QT to around £70bn next year.

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