Rates could persist at higher levels for an extended period
The Bank of England (BoE) has made an unexpected move, lowering interest rates by 0.25 percentage points to 4% in a move that some are calling a "hawkish cut." This decision, made by the Monetary Policy Committee (MPC) in a 5-4 vote on August 6, 2025, signals a careful approach to loosening monetary policy while remaining alert to inflation risks.
The current outlook for UK interest rates is one of cautious gradual easing. The BoE's decision comes as inflation, while falling significantly from its peak of over 11% in 2022, is expected to rise slightly to around 4% in the short term due to factors like higher food prices. In the longer term, the BoE expects inflation to gradually move back towards its 2% target.
The MPC acknowledges upside risks to inflation due to inflation expectations and supply-side pressures, which warrant a cautious stance on how quickly further rate cuts can be made. Regarding economic growth, underlying UK GDP growth remains subdued, and there are signs of a gradual loosening in the labor market with rising unemployment. This implies some economic slack has emerged, which supports the rationale for cutting rates to support growth.
However, global uncertainties and geopolitical risks still temper the outlook. Recent easing in trade policy uncertainty has reduced some risks, but concerns remain. Analysts generally expect two rate cuts by the end of 2025, potentially bringing the Bank Rate down further to around 3.75%, but the pace and extent of cuts will heavily depend on how the labor market evolves.
Slowing wage growth and rising unemployment are key factors that could allow for a "gradual and careful" easing of monetary policy. If inflation continues to rise, there could be no change in interest rates, especially if market pricing moves against a rate cut. Governor Andrew Bailey is now considered the committee's swing voter.
The BoE's decision has implications for public finances. The Office for Budget Responsibility's forecasts hinge on market predictions on monetary policy. If inflation continues to rise, it could complicate fiscal dynamics. The triple lock on the state pension could once again raise questions about its fairness against a fiscal backdrop suggesting tax increases are likely.
In a press conference on Thursday, Governor Andrew Bailey declined to comment on how the BoE would react to further tax rises. If inflation continues to rise, pensioners can look forward to a state pension increase of at least 4%. However, the triple lock on the state pension could cost billions of pounds more than expected if wage growth is lower than inflation.
The BoE's move has been met with mixed reactions from analysts. Some, like Anna Titareva of UBS, find the MPC's assumptions of high inflation affecting the path of interest rates "striking." Others, like analysts at Capital Economics and Oxford Economics, are less confident of another rate cut taking place in November.
Markets reacted to the BoE's meeting minutes by repricing the risk of further cuts during the rest of the year. AJ Bell's head of investment analysis Laith Khalaf said there was little chance of a surprise interest rate cut at the next decision in September.
The BoE's decision also has political implications. Rachel Reeves and Keir Starmer are reported to hold meetings on possible tax hikes. Rachel Reeves praised successive interest rate cuts, claiming they would help mortgage holders and allow businesses to borrow more for growth.
In summary, the BoE's "hawkish cut" reflects a balancing act: easing borrowing costs to support an economy showing signs of slowing, while maintaining vigilance against inflationary pressures that remain above target. The impact on public finances will partly depend on this inflation trajectory and economic growth, with slower growth and elevated inflation potentially complicating fiscal dynamics. However, the BoE aims to avoid prematurely loosening policy in a way that could destabilize inflation expectations.
- The Bank of England's decision to lower interest rates by 0.25 percentage points is part of a cautious approach to loosening monetary policy, as the economy is showing signs of slowing.
- The MPC's decision comes as underling UK GDP growth remains subdued, and there are signs of a gradual loosening in the labor market with rising unemployment.
- Analysts generally expect two rate cuts by the end of 2025, but the pace and extent of cuts will heavily depend on how the labor market evolves, as slowing wage growth and rising unemployment are key factors that could allow for a gradual easing of monetary policy.
- The BoE's move has political implications, as Rachel Reeves, a prominent political figure, praised successive interest rate cuts, claiming they would help mortgage holders and allow businesses to borrow more for growth.
