The Bank of England is preparing for a carefully crafted vote on interest rates next Thursday as policymakers weigh the benefits of lower inflation against the threat of weaker economic growth following impending tax rises.
The markets, which just weeks ago expected no change in interest rates until mid-2025, have now significantly shifted their expectations. Investors are betting that the Monetary Policy Committee (MPC) – the bank’s nine-member interest rate panel – could narrowly vote for a cut of 0.25 percentage points and bring the key interest rate down to 3.75 percent, the lowest level in almost three years.
If approved, it would be the bank’s sixth rate cut since August 2024 and would reflect the Federal Reserve’s recent decision to ease monetary policy for a second straight day.
The possibility of an impending rate cut follows a series of weaker economic data. Inflation was still above the target of 3.8 percent, but remained below the bank’s forecasts for three months in a row. Services inflation – a key indicator of domestic price pressures – fell to 4.7 percent in September, below the MPC’s 5 percent forecast.
Food price increases slowed to 4.5 percent, while private sector wage growth moderated to 4.4 percent. Meanwhile, unemployment has risen to its highest level in four years at 4.8 percent, pointing to a slowdown in the labor market.
British government bond yields have fallen to their lowest level this year as traders increasingly expect a rate cut before the end of the year. “Fears of persistent inflationary pressures have given way to worries about a faster slowdown in the labor market and overly restrictive monetary policy,” analysts at BNP Paribas noted.
Investment banks are divided over whether the MPC will trade this month or wait for clearer fiscal signals. Goldman Sachs and Nomura are predicting a close vote for a cut next Thursday, while Deutsche Bank expects the committee to be cautious and keep interest rates stable.
Sanjay Raja, Deutsche Bank’s chief UK economist, said the MPC was “very balanced” but could decide to delay measures until after the Chancellor’s Budget. Rachel Reeves is expected to announce tax rises of up to £40 billion. Analysts warn the move could dampen economic growth and strengthen the case for easing monetary policy later this year.
Economists at Investec urged caution and suggested the MPC should “wait for another batch of inflation data” before acting. However, Goldman Sachs argued that the bank should act preemptively to offset the “contractionary impulse” expected from the upcoming fiscal tightening.
Along with next week’s interest rate decision, the bank will release updated forecasts for growth, inflation, unemployment and productivity. These will be closely watched amid reports that the Office for Budget Responsibility plans to downgrade its own productivity outlook, potentially leaving a £20bn gap in the Chancellor’s financial plans.
Analysts at Pantheon Macroeconomics said a significant income tax increase “could prompt the (bank) to cut in December and again in the spring” as the twin effects of higher taxes and slowing inflation take hold.
The considered decision puts the UK at a crossroads: whether to keep pace with the US Federal Reserve’s easing cycle or pause until the full impact of the budget becomes clear. Either way, next week’s vote will be one of the most closely watched in years and will set the tone for monetary policy well into 2025.
