There's almost no chance that the Bank of England (BoE) will cut interest rates on Thursday. The best we can hope for is a hint that more cuts are coming later this year. We think the next one will come in April. But, that will depend on inflation dropping back closer to 2% as expected, wage growth slowing further and geopolitical tensions easing.

The 1% club

Given the pretty dismal ending to last year, it might be surprising that financial markets are pricing in just a 1% chance of a rate cut on Thursday. However, there are three good reasons why the BoE will want to wait a little bit longer before cutting interest rates again.

First, even though the UK economy almost certainly stalled at the end of the year, recent data suggests a pick-up is in progress. Rising retail sales in December and a jump in consumer and business confidence in January point to a post-Budget bounce in the economy. Most importantly, there were some signs of the labour market stabilising. Any rebound in growth in Q1 this year would mean that most of the weakness at the end of last year was due to Budget uncertainty, rather than softening demand, which would reduce the case for rate cuts.

Second, inflation remains sticky. We’re not worried about December’s rise in inflation to 3.4% because this was entirely driven by the timing of tobacco duty hikes and flight prices. Admittedly, headline inflation will slow sharply this year, falling to 3% in January and to just above 2% in April. But, services inflation, which is a better indicator of price pressures in the domestic economy, will stay much higher. The BoE is much more concerned with services inflation than the headline rate. That’s because services inflation is largely driven by external factors, such as exchange rates and oil prices, which the BoE can’t do much about. Indeed, the surveys pointing to a bounce in growth at the start of this year are also pointing to services inflation staying sticky at almost 4%. The BoE will be uncomfortable about cutting rates more aggressively until it’s confident services inflation is slowing as well.

Third, as interest rates get lower, they get closer to the neutral rate. The neutral rate is best explained as the level where interest rates aren’t supporting the economy, but aren’t dragging either. It’s like cruise control on your car − you’re neither accelerating nor braking. All the interest rate cuts we’ve had so far can be thought of as the BoE easing off the brake, but we’re probably not at neutral yet. The problem is, no one knows exactly where the neutral rate is. We can only estimate. Most economists think it’s somewhere around 3.5%. So, as the BoE gets closer to taking its foot fully off the brake, it’ll become more careful about not accidentally pushing down on the accelerator.

If not UK interest rate cuts now, then when?

This all means the BoE is very unlikely to cut interest rates on Thursday. The next rate cut will probably come in April. By that time the BoE will be able to see if growth has rebounded in Q1 and if inflation is closer to that 2% threshold, as signs suggest.

There probably aren’t many rate cuts coming after that though, unless the economy turns out to be much weaker than expected. We’d put the chances of a second rate cut this year at 50%.

Geopolitics clouds the rate-cut picture

As if all that isn’t enough to think about, two big geopolitical events are clouding the picture. The big fall in the dollar this year will help to lower inflation a bit. That’s because a lot of what the UK imports (energy, food, etc) is priced in dollars. As the dollar falls those imports become cheaper for us to buy. However, at the same time, the price of many commodities is soaring. Oil prices are up 15% this year due to rising tensions in the Middle East, for example. To some extent these two things offset each other. But, higher commodity prices are winning out. The price of a barrel of oil has risen from £45 in December to £50 currently. That’s a smaller rise than in dollars, but still enough to put some upward pressure on inflation. The risk is that energy prices go even higher, which prevents inflation falling back to 2% and denies the BoE the chance to cut interest rates again.

Ultimately, all these factors are likely to make the BoE more cautious about future rate cuts, not less. We still think rates have a bit lower to go, but it might take a while to get there.

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