Bank of England Cuts Interest Rates

By Andy Bruce, Suban Abdulla, and David Milliken

LONDON (Reuters) – The Bank of England cut interest rates on Thursday for only the second time since 2020, indicating future reductions would likely be gradual due to expectations of higher inflation and economic growth following the British government’s first budget.

The Monetary Policy Committee voted 8-1 to reduce rates to 4.75% from 5%. Analysts polled by Reuters were expecting a 7-2 vote, with only Catherine Mann advocating for maintaining rates.

Sterling increased by two-thirds of a cent against the U.S. dollar, but investors' expectations for rate cuts in 2025 largely remained unchanged.

Governor Andrew Bailey stated that "we can't cut interest rates too quickly or by too much" but noted that if the economy progresses as expected, rates will likely continue to fall gradually. He mentioned that faster rate cuts may be possible if inflation continues to fall below forecasts.

The Bank of England began reducing borrowing costs in August amid signs of easing inflation pressures, while maintaining a cautious approach, including a hold on rates in September.

Last week’s budget, featuring extensive borrowing and spending, led investors to reassess the timeline for future rate cuts. Bailey opined that the budget's impact would not significantly alter the planned rate path.

The BoE believes the government's budget plans could boost inflation by nearly half a percentage point at its peak in slightly over two years, extending the timeline for reaching the central bank's 2% target sustainably by an additional year.

The BoE projected a 0.75% boost to the size of Britain’s economy next year but advised little improvement in annual growth rates over the next two to three years. Finance Minister Rachel Reeves and Prime Minister Keir Starmer have emphasized stronger growth in their strategies.

Reeves welcomed the Bank’s rate cut, and ING economist James Smith remarked that despite increased spending, the Bank of England does not view the budget as a decisive factor for future interest rate cuts. Projections suggest the Bank will keep rates on hold in December, potentially accelerating cuts from February onward.

CONSIDERING TRUMP POLICIES

The BoE did not reference Donald Trump’s upcoming election victory, which may reduce expectations for aggressive Federal Reserve rate cuts. Bailey noted he would monitor Trump's trade policies but found it premature to draw conclusions.

Suren Thiru, economics director at the Institute of Chartered Accountants in England and Wales, remarked that inflationary pressures stemming from the budget and growing global risks, especially concerning new U.S. tariffs, could lead to a more cautious loosening of policy.

Investors speculate the BoE will reduce rates at a slower pace than the European Central Bank, with the Fed anticipated to cut rates by a quarter percentage point on Thursday.

Following the rate decision, financial markets anticipated between two and three rate cuts from the BoE in 2025, down from around four before the budget announcement.

HIGHER INFLATION AFTER BUDGET

The BoE projected inflation would rise to around 2.5% by the end of 2024 from 1.7% in September, and to 2.7% by the end of 2025, before gradually falling below the 2% target by mid-2027.

Upcoming government decisions to increase bus fare caps, raise VAT on private school fees, and hike employers' social security contributions are expected to elevate inflation.

Coupled with a 6.7% increase in the national minimum wage, employers are likely to face rising costs. However, Bailey noted the reaction of businesses to these changes remains uncertain.

BT and Sainsbury's have indicated that tax changes from the budget will fuel inflation.

Bailey remarked that the central bank's gauge for price pressure – inflation in the services sector – continues to be too high.

While the BoE revised its economic growth forecast for the year down to 1% from 1.25%, it increased the 2025 forecast to 1.5% from 1%. This adjustment reflects the stronger government consumption and investment paths more than counterbalancing the growth impact of heightened taxes.

The BoE clarified that its inflation and growth forecasts consider the effects of increased spending and tax measures but exclude the significant rise in market borrowing costs post-budget. Including current higher market interest rates would likely lower the outlook for inflation and growth.

The BoE maintained its forecasting convention to minimize market volatility, planning to reassess market interest rates in December.