Bank of England moves to cut interest rates

The Bank of England started its easing cycle as the Monetary Policy Committee (MPC) voted to cut interest rates in a narrow 5-4 split. The data evidence ahead of the meeting suggested the decision would be finely balanced, although market pricing implied more than a 60% chance of a cut before the vote. Governor Bailey signalled the Bank would be ready to pause its easing cycle if the inflation outlook worsened. Nonetheless, we expect the Bank to cut twice more this year, taking interest rates down to 4.5% by the end of the year.

The decision was accompanied by a revised set of forecasts, which saw the Bank upgrade its outlook for growth. The economy has been supported by a broad-based pick-up in activity since the start of the year, with both hard data and soft survey data pointing to a recovery in interest rate sensitive sectors such as construction and manufacturing, buoyed by expectations of rate cuts and an improvement in external conditions.

The risks to the outlook in our view are balanced. On the upside, we could see further acceleration in consumer spending in the second half of the year, underpinned by healthy household balance sheets and improved consumer sentiment. On the other hand, the expected rise in inflation in the autumn could have adverse second round impacts which may contribute to further persistence in underlying inflation and rates staying in restrictive territory for longer, which would dampen momentum. External headwinds  also remain for a weaker economy, with a potential worsening geopolitical landscape impacting trade and business confidence.

While the improved economic outlook could have strengthened arguments to hold rates steady, the MPC will have been reassured by the fact that strong growth in activity was accompanied by a loosening in the labour market over the last few months. Vacancies have fallen, unemployment trended up slightly and wage growth also continued to soften, albeit remaining at an elevated level. Crucially, the Bank’s latest projections suggest the labour market will continue to loosen over the coming year, with private sector wage growth set to fall to 3% and unemployment set to rise to 4.75% in 2025. Forward looking survey evidence also suggests a continued normalisation in wage settlements by businesses, with expected wage growth over the next 12 months falling to 4% in the latest Decision Maker Panel Survey. We do not expect the recently announced pay settlements for public sector workers to have a major lasting implication on the overall wage growth momentum in the UK at this point.

Developments on the inflation front have been less positive. Although headline inflation remained on target for the second consecutive month in June, underlying inflationary pressures have been more concerning. Services inflation came in at 5.7% in June, significantly above the Bank’s May forecast. However, as the Bank underlined in the minutes of the meeting, this was driven mainly by volatile and seasonal components of inflation, including index linked prices and accommodation and rents. These components provide little insight into the degree of persistence in underlying domestic inflation. The Bank’s latest projections for inflation continue to see a return to target in early 2026 and falling below target by the end of the forecast period. Ultimately this was enough to convince a slim MPC majority that inflation will return sustainably to target in the medium term.

The run up to the meeting saw little communication from the MPC, even after the end of the election blackout in early July. The Bank was likely cautious of moving market expectations towards either side, ensuring a degree of flexibility in a relatively split Committee. The MPC instead allowed the data flow since the last meeting and the updated quarterly projections to determine the outcome. That approach was reaffirmed by Governor Bailey in the press conference, suggesting that further easing would be conditional on the Bank’s assessment around the progress in reducing domestic inflationary pressures and the risks to the inflation outlook.

The relatively split MPC decision likely means the pace at which the Bank approaches neutral rate will only be gradual. Risks are skewed towards fewer cuts, particularly if progress on underlying inflation is insufficient. The expected rise in headline inflation over the coming quarters also raises uncertainty around the potential adverse second round effects. Nonetheless, we think the language in the statement still leaves the door open for more easing in the second half of the year and is broadly in line with our expectation of two further cuts this year.