As expected, the Monetary Policy Committee (MPC) voted by 5-4 at its latest meeting to cut interest rates to 3.75%. Since the MPC last met, the labour market has continued to weaken, the economy contracted for two consecutive months and inflation has dropped to 3.2% from 3.8%, making it an easy choice. Looking ahead, we think the MPC will cut just once more next year, leaving rates at 3.5%. With the Bank Rate now approaching neutral, which raises the bar for any further rate cuts, the MPC would need to see a sustained weakening in the labour market to be convinced to cut below 3.5%.

Weak UK economic data secures another rate cut

The MPC voted to cut interest rates to 3.75% in December, as we expected. Since the MPC’s last meeting, the unemployment rate has risen quicker than anticipated, the economy has contracted and inflation came in 0.2ppts lower than the MPC’s forecast for November. This paved the way to another rate cut.

Indeed, the December 2025 Monetary Policy Summary and Minutes confirm that since the MPC’s last meeting: “The risk from greater inflation persistence has become somewhat less pronounced since the previous meeting, while the risk to medium-term inflation from weaker demand remains.” Translating that from central bank speak, the Committee thinks there’s now more chance of growth disappointing, which would help to lower inflation and allow the MPC to keep cutting interest rates.

That said, the tight 5-4 vote split shows that the Committee is clearly still worried about inflation. Services inflation, which is more reflective of domestic inflationary pressures, remains elevated at 4.4%. The MPC emphasised that underlying inflation pressures were also likely to remain elevated, despite the Chancellor’s cost-of-living measures reducing headline inflation by around 0.5ppts in April next year.

On balance, weak near-term data set against sticky inflation expectations and stubborn forward-looking pay indicators explain why only Governor Bailey was swayed to change his vote from the last meeting and suggests the bar to future rate cuts is relatively high.

MPC one and done next year

Looking ahead, the MPC kept the guidance that the Bank Rate would remain on a “gradual downwards path”. However, it also added that “judgements around further policy easing will become a closer call”. This was added for a couple of reasons.

First, most estimates of neutral − where interest rates are neither supporting nor weighing on activity − are around 3.25−3.5%. This is hard to judge, so the MPC will shift its focus to not undershooting neutral, which would allow inflation to rise. This will require a slower pace of easing to make sure interest rates aren’t cut too far and too fast. Governor Bailey hinted as much in his closing remarks: “While I see scope for some additional policy easing, the path for Bank Rate cannot be pre-judged with precision, recognising in part the more limited space as Bank Rate approaches a neutral level.” This prompted markets to revise down the odds of further rate cuts in Q1 2026.

Second, the MPC’s hawks continue to be more concerned by upside risks to inflation. Even Governor Bailey noted concern that “inflation expectations have not yet shifted downward sufficiently”, despite inflation dropping by 0.6ppts over the last couple of months. Indeed, as the MPC approaches neutral and underlying inflation remains persistent, there’ll be a high bar to further rate cuts.

Ultimately, we think the MPC will cut once more in the first half of 2026, leaving interest rates at 3.5%, which is our estimate of neutral. However, if labour market weakness turns out to be genuine and helps to weigh on pay growth, and therefore services inflation, then we think the MPC may have the space to cut interest rates slightly further into the second half of the year.

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