MPC preview: No early Christmas present from the MPC

There seems little chance of the Bank of England (BoE) following the European Central Bank (ECB) and cutting interest rates next week. We’re expecting the Monetary Policy Committee (MPC) to keep interest rates on hold at 4.75%, with an 8-1 vote. We also doubt the committee will make any change to its forward guidance that a “gradual approach” to lowering interest rates is appropriate. Ultimately, that means mortgage holders won’t be getting an early Christmas present from the Bank this year. 

We expect four cuts in 2025, meaning rates will finish the year at around 3.75%, but the risks are weighted towards fewer rate cuts.

Weakening growth vs higher inflation 

The economy has weakened over the past few months. Growth in Q3 came in at just 0.1% q/q and business surveys, such as the Purchasing managers index (PMI), are suggesting that Q4 will be just as weak. What’s more, the labour market appears to be softening, although the collapse in the response rate to the labour force survey makes it impossible to know with any real confidence. Hiring appears to have been put on pause and the unemployment rate jumped to 4.3% in September. 

At face value, all that would point to the need for the BoE following the ECB and cutting rates by another 25bps at its meeting on Thursday. 

However, Q3 GDP was dragged down by some one-off erratic issues, underlying growth was considerably stronger. And it seems likely that the business surveys are being dragged down by negative sentiment after the budget, meaning that the economy is likely holding up better than the surveys are suggesting. Indeed, the final PMI was significantly revised up compared to the flash number, which was collected in the weeks immediately after the budget. Of course, while the budget does impose significant extra costs on businesses, that impact will be more than offset by higher government spending acting as a tailwind to the economy next year. 

So, while the latest economic data hasn’t been encouraging, we doubt it will be enough to push the MPC into a consecutive rate cut, especially as inflation pressures are rebuilding. 

Inflation likely rose to 2.6% in November and will continue rising to around 3% by early next year. At the same time, wage growth is still high and is likely to accelerate again over the next few months as big public sector pay deals come into effect. 

There are also a series of risks on the horizon that could materially increase inflation. The geopolitical situation in the Middle East and Russia is clearly volatile, it’s unclear how much of the increase in costs from the budget firms will try to pass on and new economic policies in the US could raise inflation in the UK either through the impact of tariffs or via a stronger dollar. 

Ultimately, the MPC is likely to decide that the risk of inflation rising again and becoming entrenched, outweighs the risk that economy is slowing. 

Four interest rates cuts next year, but risks weighted to fewer 

The outlook for interest rates next year will heavily depend on how firms respond to the increase in payroll costs imposed in the budget. We are expecting most of the impact to be reflected in slower pay growth in the second half of next year, which would give the Bank more room to cut rates. But if instead firms opt to pass on the costs to customers, inflation would be higher than expected and result in fewer rate cuts. 

For now, though, the MPC has signalled that cuts of approximately one per quarter is likely to be appropriate. We think the MPC will be relatively relaxed about cutting interest rates until they get to around 4%. Above this level rates are still clearly in the restrictive range so a gradual reduction is unlikely to reignite inflation. Below 4% and the MPC is likely to be more cautious as it approaches the theoretical neutral rate. We expect interest rates to eventually settle at around 3.5%. 

Sign up to our Real Economy communications for regular commentary and analysis from Tom on the changing economic landscape.