It’s a solid bet that the Bank of England (BoE) will cut interest rates by 25bps to 4% at its meeting on Thursday. The committee is likely to stick to its gradual and cautious guidance, but the vote will probably be split three ways this time, with two members voting for a 50bps cut, five voting for a 25bps cut and two wanting to keep rates on hold.

However, the outlook after next week’s meeting becomes much cloudier. We still expect another 25bps cut towards the end of the year, but that will largely depend on whether or not the recent labour market weakness turns out to be a trend or a blip.

Labour market concerns pip inflation worries, for now…

We don’t think there is enough in the recent data to shift the MPC off its quarterly rate-cutting path. GDP will likely be only a shade weaker in Q2 than the committee forecast, and the unemployment rate is slightly higher, but this is balanced out by inflation running a little above the latest forecast.

Ultimately, the decision will come down to whether the committee puts more weight on the weak labour market – particularly whether this is enough to bring down services inflation in the medium term – or the stickiness of inflation and the risk of a re-acceleration. There is plenty of meat for both the hawks and the doves here and one can make a convincing argument either way.

The hawks will point to the upside risks from inflation, especially that headline inflation is likely to move dangerously close to the 4% level that the MPC has previously flagged as where households really start to grow concerned and where food inflation is accelerating rapidly.

What’s more, inflation expectations are looking increasingly unanchored. Forward-looking survey data also suggests the worst for the economy and the labour market is now in the rear-view mirror.

Doves will argue that weak payroll numbers, even though they have been revised up, still point to a rapidly weakening labour market. The latest data also shows a sharp slowdown in pay growth to 4.9% – well below the Bank’s forecast of 5.2% – again pointing to potential slack opening up in the labour market.

Clearly, the doves have the upper hand currently, with markets pricing in a 90%+ chance of a rate cut next week. We agree with the market and expect a 25bps cut.

However, this split in the MPC will make communicating a clear path forward particularly tricky. The committee will likely stick with its “gradual and careful” guidance and will emphasise again that “policy is not on a pre-set path”, but the vote is likely to be a three-way split. We think a 2-5-2 split is most likely.

UK interest rate predictions: how will the Bank of England tackle cut rates?

Looking to the rest of the year and into next, the direction of interest rates becomes less clear. We think the labour market will remain weak enough, which will feed into slowing pay growth, to justify one more rate cut towards the end of the year, despite inflation remaining high.

However, if the labour market recovers as survey indicators suggest, then services inflation will remain sticky, especially if it becomes apparent that another round of increases of duty and 'sin tax' increases will keep inflation high next year. The BoE may then opt to skip any rate cut pencilled in for November or December (see chart).

Looking further into next year, the committee will have to be more careful about further cuts once interest rates drop below 4%. Even if we take Professor Alan Taylor’s estimate of the neutral interest rate of 2.75% (plus or minus 50bps), which is probably towards the lower end of estimates as given, then as the actual interest rate approaches neutral, the committee will have to be even more gradual and even more cautious in easing policy.

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