Bank of England cuts interest rates despite looming inflation surge
The Bank of England cut interest rates by 25 basis points on Thursday, even though rate-setters expect to see a significant rise in inflation over the coming year.
Seven members of the Bank’s Monetary Policy Committee (MPC) backed the decision, while two – Swati Dhingra and Catherine Mann – voted for a larger 50 basis point cut.
The decision means that the benchmark Bank Rate stands at 4.50 per cent, down from a peak of 5.25 per cent.
The Bank also slashed its forecast for UK economic growth to just 0.75 per cent for 2025.
While investors had expected the Bank to cut rates, many thought that at least one member of the MPC, likely Mann, would have voted to hold rates steady.
Andrew Bailey, the Bank’s Governor, said: “We’ll be monitoring the UK economy and global developments very closely and taking a gradual and careful approach to reducing rates further,”
The vote split suggests the MPC is increasingly concerned with weakness in the economy, meaning they will look through the anticipated resurgence in inflation.
Inflation will rise to a peak of 3.7 per cent in the third quarter of this year, according to the Bank’s latest forecasts, a significant upgrade on its previous assessment of 2.8 per cent.
The increase will largely be driven by higher global energy prices, which have surged since November. Regulated prices like water bills and bus fares will also play a role, the forecasts suggest.
However, the MPC continued to predict that the Budget tax hikes would only have a limited pass-through to consumer prices.
Bank of England warns on inflation
Although the headline rate will rise, MPC members noted that progress on underlying inflation has continued in recent months.
Services inflation has fallen further than expected, while wage growth is expected to “slow significantly” by the end of 2025, the MPC said.
It predicted that the pickup in headline inflation would “not lead to additional second-round effects” which would derail progress on underlying inflation.
Inflation will eventually return to target in the final quarter of 2027, two quarters later than the Bank predicted in November.
These forecasts are based on market expectations. At the time of the forecasts, traders expected just two rate cuts in 2025, with the Bank Rate only expected to fall to 4.0 per cent by the end of the period.
This implies that a more aggressive pace of monetary easing would contribute to even stickier inflationary pressures.
But the Bank also slashed its growth forecasts for 2025, primarily reflecting weakness on the supply-side of the economy.
UK economy growth forecasts downgraded
The Bank now expects the economy to grow 0.75 per cent in 2025, a chunky downgrade compared to its previous estimate of 1.5 per cent.
This will come after a very subdued end to 2024. The economy has been “broadly flat” since March, the MPC noted.
Growth is then expected to pick up from the middle of 2025. The Bank forecast that the economy would grow around 1.5 per cent in 2026 and 2027, which was little changed compared to November.
The MPC noted that there was a great deal of uncertainty about the balance of supply and demand in the economy which would help determine the appropriate level for interest rates going forward.
Longer-lasting weakness in demand would warrant a “less restrictive path of Bank Rate” while continued constraint on the supply side could “sustain domestic price and wage pressures,” the Bank said.
The forecasts were finished before Donald Trump imposed tariffs on China, and so do not include “any explicit impact” from trade uncertainty.
However, the MPC suggested the broad imposition of tariffs around the world would “likely be negative” for UK growth while there was “significant uncertainy” around the possible impact on inflation.
Some economists – including Dhingra – have suggested that large tariffs could actually push inflation lower, as major exporters would cut prices to maintain market share.
The Bank of England’s decision comes a week after the ECB cut rates for the fifth consecutive meeting, while the Fed left rates on hold citing the continued strength of the US economy.