MPC preview: tariff hit opens door to more rate cuts

It’s a sure bet that the Bank of England (BoE) will cut interest rates to 4.5% next week, probably by a 7-2 vote with two members preferring to cut by 50bps.

We continue to expect the BoE to keep its recent pace of quarterly cuts. That means interest rates would fall to 3.75% by the end of the year.

There is a chance of consecutive cuts in May and June. However, we think inflationary pressures will keep the Monetary Policy Committee (MPC) on its quarterly path unless there is clear evidence in the data of a downward shift in growth.

Q1 growth picked up, but irrelevant now

Prior to the tariff announcements at the start of April the UK economy appeared to have been returning to growth.

Retail sales increased for three consecutive months and we had pencilled in growth of 0.5% q/q; double the MPC’s forecast of 0.25%.

However, tariffs and the uncertainty around them have made the Q1 data largely irrelevant and we doubt the MPC will put much weight on it.

The bigger question facing the MPC is how tariffs will change the outlook for growth and inflation.

Field tilted towards more rate cuts

The turmoil and uncertainty created by Donald Trump’s tariff policy has undeniably tilted the field towards more interest rate cuts.

There was a sharp drop in both business sentiment and consumer confidence in April. The headline Composite PMI declined to its lowest level since November 2022 and the GfK Consumer Confidence Index fell by four points to -23.

Admittedly, the PMIs tend to overreact to political events, so we doubt the economy fell off a cliff in April. There is also a big question over how much of this fall in consumer confidence will translate in spending. Nevertheless, a slowdown in growth from what looks like a decent 0.5% q/q rise in Q1 looks inevitable.

At the same time, the sharp fall in global commodity prices like oil, the price of which has dropped by over $14pb since the last MPC meeting, will help to take some of the sting out of the coming rise in inflation.

Crucially, the UK has so far avoided imposing any retaliatory tariffs, which would push inflation up and make the policy response more difficult.

There’s also the first hard evidence in the lower employment figures that some of the collapse in the labour market predicted by surveys after the Autumn Budget in October is now feeding through.

The number of people on payrolls dropped by 78,000 in March, which was the biggest fall since the pandemic. While we take this number with a pinch of salt because payroll numbers are volatile and often revised up, this figure suggests firms did take a conscious decision to shrink their workforces ahead of April’s tax rises and its chunky increases in National Minimum (NMW) and Living Wages (NLW). Indeed, the traditionally lower-paid hospitality and retail sectors saw the largest drops in employment with both trimming their payrolls by a headcount of around 17,000 each.

This combination of a loosening labour market, weaker economic growth and softer commodity prices gives the MPC a bit more room to cut interest rates this year.

However, the MPC’s ability to cut rates to support the economy will be restrained by a coming jump in inflation. Survey data since the Autumn Budget has suggested that a significant majority of firms intend to pass on higher employment costs once they came into effect in April. And this is borne out by the latest data. The Composite PMI output price balance hit its highest level in nearly two years despite weakening output growth. What’s more, the usual annual price resets and increases in regulated utility prices will combine to push inflation to around 3.5% in April and probably keep it around that level until the winter.

Admittedly, that is better than the 4% peak we had been expecting, but it is still fast enough to keep the MPC on guard. This is especially since the apparent labour market slowdown does not seem to have filtered through into private sector wage growth. It is still running at almost 6% and twice the 3% that is roughly consistent with 2% inflation.

The MPC clearly still has some work to do before it can declare that the inflation genie is back in the bottle. The big question is how much of that work will now be done by tariffs and how much remains to be done by interest rates.

Easily enough cover for a rate cut, but too much risk for the MPC to change track

Ultimately, the MPC has more than enough evidence to justify a 25bps rate cut next week. The case for a 50bps cut looks shakier. There hasn’t been enough hard data to convince anyone that the tariff turmoil that has collapsed many of the surveys will actually translate into a significant slowdown in the real economy. There is also always the chance of a significant rollback in US policy that changes the outlook again.

We think the MPC will flag it is becoming more concerned about the growth outlook, perhaps by putting more emphasis on its downside scenario. However, we still expect the MPC to stick with its “careful and gradual” message. This is partly because it will want to see how April’s rise in employment costs is translating into employment and inflation and partly because it will want to see how much of the recent tariff-induced fall in sentiment translates into a reduction in real activity.

If there is a significant change in guidance, then it is likely to suggest that the bar for consecutive rate cuts has been lowered. Indeed, we think there is now a decent chance of a rate cut in May, June and September.

For now, though, we are sticking with our view of one rate cut per quarter, which would take rates down to 3.75% by the end of the year.

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