Bank of England stands pat on interest rates, but cuts expected ahead

The Bank of England maintained its key interest rate at 3.75% on Thursday amid ongoing inflation concerns, though a surprisingly close vote signals potential cuts on the horizon.

The decision to hold rates steady was expected by financial markets, but the 5-4 split among the Monetary Policy Committee members caught many analysts off guard. Four committee members voted for an immediate quarter-point reduction, suggesting growing internal pressure to ease monetary policy.

The central bank has been on a cautious rate-cutting trajectory over the past 18 months, typically adjusting rates quarterly. Its last reduction came in December, with indications that further cuts would likely follow throughout 2024.

Economic forecasts released alongside Thursday’s announcement painted a mixed picture of the UK economy. In a positive development, the Bank now expects inflation to return to its 2% target by spring, approximately a year earlier than previous projections. This accelerated timeline largely stems from cost-of-living relief measures announced in Treasury chief Rachel Reeves’ November budget, particularly those addressing energy bills.

“We now think that inflation will fall back to around 2% by the spring,” Bank Governor Andrew Bailey said. “That’s good news. We need to make sure that inflation stays there, so we’ve held rates unchanged at 3.75% today. All going well, there should be scope for some further reduction in Bank Rate this year.”

The improved inflation outlook comes at a critical time for Britain’s Labour government, which has seen its public support erode since taking office in 2024. Prime Minister Keir Starmer’s administration is banking on sharply falling inflation to enable further interest rate cuts, potentially stimulating economic growth and easing financial pressure on mortgage holders and businesses.

However, the Bank’s updated economic forecasts weren’t universally positive. Growth projections for 2024 were downgraded from 1.2% to 0.9%, and 2027 forecasts slipped from 1.6% to 1.5%. The unemployment rate is now expected to climb to 5.3% this year, worse than November’s projection of 5.1%.

The delicate balancing act faced by the Bank illustrates the complex economic challenges confronting the UK. Lower interest rates typically stimulate economic growth by reducing borrowing costs for consumers and businesses, encouraging spending and investment. However, they can also fuel inflation if implemented too aggressively.

The UK’s inflation rate currently sits at 3.4%, still above the Bank’s 2% target despite significant progress from the double-digit figures seen in 2022. This persistent inflation, coupled with signs of economic resilience, explains the cautious approach from the majority of committee members.

Market observers and economists now widely anticipate at least two more quarter-point rate cuts before year-end, with the next policy meeting in March firmly in focus.

“A cut at the next meeting in March is most certainly on the table,” said Luke Bartholomew, deputy chief economist at Aberdeen. “And even if it takes a bit longer for the next cut to come through, we still think there is a strong case for rates to eventually fall to 3% later this year.”

The close vote split suggests a potential shift in the committee’s stance, with markets now pricing in a higher probability of a March reduction. Such a move would continue the trend of gradual monetary easing while allowing policymakers to monitor inflation’s trajectory and assess broader economic indicators.

For UK households and businesses, particularly those with variable-rate mortgages and loans, the prospect of further rate cuts represents a potential financial relief amid ongoing cost-of-living pressures. However, the measured pace of reductions indicates the Bank remains wary of unleashing inflationary pressures that could require painful policy reversals later.