Bank of England cut interest rates to 4.75%

MPC encouraged by progress on underlying inflation

The data flow since the September meeting, in addition to the updated forecasts, provided the MPC with a strong justification to cut. Headline inflation continued to ease, falling to 1.7% in September and crucially, services inflation fell to 4.9%. Both were significantly lower than the MPC’s August projection.

The latest forecasts show inflation rising slightly over the coming months, largely due to base effects from energy prices. The BoE now expects inflation to rise in 2025 before edging closer to target during 2026, and to fall below target through parts of 2027, suggesting the risks to the inflation outlook would become more two sided if rates remain too restrictive.

The labour market has been a persistent upside risk for inflation, but developments over the summer months have been reassuring for the BoE. While headline unemployment has remained relatively low, other measures of labour market activity have pointed to a continued slowdown. Vacancies in the three months to September fell to their lowest level in three years, with a broad-based decline across most sectors. Meanwhile, wage growth fell to 4.9% in August, its lowest level in over two years. More timely survey data reinforces the weakening labour market picture, showing both an improvement in staff availability and declining demand for workers.

Fiscal loosening raises risk to inflation outlook

While the Governor was dovish in the run up to the meeting – stating that the pace of rate cuts could pick up – the recent loosening in the Budget has significantly changed the macroeconomic landscape. The Bank has upgraded its growth outlook with the latest forecast showing the economy growing by 1% this year and 1.5% next year, broadly in line with our own recently updated projections. However, this was accompanied by an upward revision to the medium-term inflation outlook. The UK economy’s supply side constraints have been a key concern for the MPC, which has judged that the recently announced fiscal loosening will put upward pressure on inflation, despite the recent downward surprises to underlying inflation.

Path for interest rates becomes more uncertain

The Bank’s use of three alternative cases for wage and inflation persistence emphasize the uncertainty regarding the structure of the economy, which further complicate the task of policymakers. The central case, which forms the basis of the latest forecast suggests that a period of economic slack may be required to normalise the dynamics of wage setting. Furthermore, despite encouraging progress on the labour market and services inflation, the recent fiscal loosening has increased the possibility of inflation staying above target over the coming years. This will likely see the BoE continue its gradual approach to cutting interest rates over the coming year. The BoE likely has no further room to cut this year. We expect the pace of cuts to ease slightly in 2025, with the MPC potentially not cutting during each forecast meeting. We see interest rates settling at around 4% by the end of 2025 in line with current market pricing.