Bank of England: Still going gradually (and now carefully too)

As expected, the Bank of England cut rates by 25 basis points (bps) to 4.50%, continuing their gradual rate cut path. The vote though, at 7-2 was effectively more dovish than expected.

Rather than one or two members voting to keep rates on hold, two monetary policy committee (MPC) members voted for 50bps cuts. One of those was Catherine Mann, who last year had one of the most hawkish voting records on the MPC. She had previously said she felt they should stay on hold for longer having been one of the MPC members most worried about the risk of inflation persistence. However, she then stated that when underlying inflation dynamics changed that the MPC should go for larger cuts – though it isn’t obvious that is what drove her decision at this meeting, as the minutes don’t attribute individual views.

the vote was more dovish than I’d expected, with a previously hawkish member of the committee voting to cut rates by 50bps

Why they cut… and several ways in which they sound on track for more:

• First, they judge that monetary policy remains clearly restrictive.
• Second, they sounded reasonably confident that inflation is on the right path. The MPC noted that “progress on disinflation in domestic prices and wages had generally continued.” They noted a moderation in services inflation (the monetary policy report notes that underlying services inflation is moderating too) and they expect wage growth to slow to around 3.75% by year end (saying that would be consistent with their agents’ survey and their own decision maker panel business survey).
• Third, they have become a bit more downbeat on the economy. They flag some of the deterioration seen in recent UK activity indicators (though they think GDP growth will pick up a bit from the middle of this year).
• Fourth, they already expect inflation to jump in the near term to 3.7%. On that basis, headline inflation looks less likely to surprise them on the upside this year, at least as long as the upside comes from energy and goods prices. Importantly, they judge that this inflation spike won’t lead to second round effects given the labour market is now looser.
• Fifth, the vote was effectively more dovish than I’d expected, with a previously hawkish member of the Committee voting to cut rates 50bps (as noted above).

But not as dovish as that vote change might suggest – still gradual (and, now ‘careful’ too): While all the above might look consistent with the BoE picking up the pace of rate cuts soon, that wasn’t so apparent in the views of the majority.

• In the opening statement, Governor Bailey reiterated that a “gradual and careful approach remains appropriate.” He later said that there was a debate about this second word though and that differences in view in the majority camp on the MPC (i.e. those voting to cut rates 25bps today) boiled down to a choice between the words ‘careful’ and ‘cautious’. On ‘careful’ he implied that reflected the greater uncertainty they see in this environment, both domestic and externally (domestic uncertainty reflects lack of clarity around the degree to which supply and demand are moving).
• The minutes went into some detail on the different views of the seven MPC members voting to cut rates which crudely break down into ‘keep cutting gradually’ and ‘still worried about upside inflation risk so go cautiously and gradually’.
• In addition, the views of the two voting to cut 50bps are split out and the vote of one reflected a desire for “a more activist approach at this meeting would give a clearer signal of financial conditions appropriate for the United Kingdom, even as monetary policy would need to remain restrictive for some time to anchor inflation expectations, and Bank Rate would likely stay high given structural persistence and macroeconomic volatility.” That does not sound like the most dovish rationale for a 50bps rate cut.
• They are also now placing more weight on their second and third ‘cases’ so implicitly less on their first case (scenario). Their first case was effectively the most dovish one where an unwinding of past global shocks led to weaker pay and price-setting.
• As for their forecast – they have built in higher inflation into their forecast. If you track their forecast out two years ahead, even with an unchanged interest rate, their median inflation forecast is a touch above the 2% target. That doesn’t obviously support lots more rate cuts, although inflation would then drop below their 2% target in the third year of that forecast.

Re-examining R* (neutral rate): They have had another look at the long-run equilibrium rate (which they present as a kind of long-term anchor for monetary policy, while not guiding policy month-to-month). They think there is evidence that it has risen since they last assessed it in 2018. In 2018 they assessed it as being in a 2-3% nominal range. They lay out a number of estimates of the likely change in R*, which suggest around a 25-75bps increase since 2018 (so, presumably now more like a 2-4% range for neutral). That updated range would be in line with my own central estimate of around a 3.25% medium-term neutral rate for the UK (3% longer-term).

BoE on tariff/Trump risks – uncertain implications for monetary policy: In a box in the monetary policy report, they suggest that the impact of higher US tariffs would likely lower UK economic activity. But they think that the overall impact on UK inflation is unclear and “sensitive to changes in other countries’ trade policies and the relative strength of different economic channels, particularly the impact on exchange rates.” Hence, they think that the direction of any appropriate monetary response is unclear.

What does all this mean for the rate path ahead: The core gradual and careful messaging sounds like a central bank still on a 25bps a quarter rate cut path to me, despite those higher inflation forecasts. Three more rate cuts this year – on that basis – seems a reasonable central case with that in mind, but with a reasonable probability they step up the pace if the data validates their expectation on wage growth and inflation and, alongside continued weakness in UK activity growth, reassures them that supply is less constrained relative to demand. For now, I continue to expect the next rate cut in May.

The fund manager view – Ben Nicholl, Senior Fund Manager, Rates & Cash

At Thursday’s meeting the Bank of England voted to cut interest rates by 25bps from 4.75% to 4.50%. While this outcome was fully priced by the market, few, if any, were expecting two members of the committee to vote to cut interest rates by 0.50%. If anything, most were expecting at least one member of the committee to dissent and vote for no change in interest rates. The immediate market reaction saw gilt yields move sharply lower, as the market interpreted the vote breakdown as a sign that the MPC might be moving towards a more aggressive stance in easing monetary policy. But as is often the case, the devil was in the detail of the minutes that followed the decision, and it would appear, at least for now, that the central body of the committee remains wedded to a ‘gradual’ and now ‘careful’ approach to easing monetary policy.

The meeting was the first monetary policy report month of 2025, providing the BoE with an opportunity to revise a number of forecasts, particularly around growth and inflation. Growth has been weakening for some time, with the decline having accelerated since the Budget. The BoE took a knife to its growth projections, slashing its forecasts for 2025 GDP by half from 1.50% to just 0.75%. Should the Office of Budget Responsibility (OBR) do the same early next month, then the chancellor may have little choice but to either reduce spending or raise taxes further in order to remain within the new fiscal rules.

Whatever action is taken will only weigh further on growth. With respect to inflation, the committee sounded reasonably confident that inflation was on the right trajectory, despite projections for CPI to rise as high as 3.70% this year, and to remain significantly above target for much of 2025 and well into 2026. Perhaps more importantly than headline inflation though is the outlook for services inflation and wages, where the BoE expect wage growth to slow to around 3.75% by the end of the year 2025. However, if growth continues to deteriorate and the labour market weaken, that too could prove optimistic.

Ultimately the MPC did little to shift the dial on the status quo. Which for now the market is still interpreting as one cut of 0.25% each quarter, leaving base rates around 3.75% by the end of 2025. While the MPC is set to target CPI inflation at 2.0%, there is a growing feeling that the BoE might be getting behind the curve. Headline CPI is likely to remain sticky for much of this year, but growth is slowing much faster than the BoE projected just a few months ago. Headwinds from the budget, and any additional policy adjustments on spending or tax will weigh further, as could global developments, particularly from US economic policy.

It is our view that the risk reward outcome for domestic growth remains tilted to the downside, and that UK base rates will end the year below the 4.0% level being priced by financial markets. While UK government bond yields have moved sharply lower from their January 2025 yield highs, we believe that they remain an attractive proposition for investors at these levels, particularly in shorter maturities.

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