The Bank of England cut interest rates by 25 basis points as scheduled, suggesting that weakening inflation is expected to lead to further easing next year
The Zhitong Finance App learned that the Bank of England's monetary policy committee decided to lower the benchmark interest rate by 25 basis points to 3.75% with a 5:4 vote on Thursday, the lowest level in nearly three years, in line with market expectations. This is the first time since August that the Bank of England has cut interest rates. At the previous two policy meetings, the Bank of England chose to stay on hold. Bank of England Governor Bailey chose to support the much-anticipated easing measure of cutting interest rates by 25 basis points after a series of recent data showed a downward trend in the UK's economic growth, job market, and price pressure.
At the same time, the Bank of England also hinted that inflation will cool down enough to further ease monetary policy in 2026. The central bank currently expects inflation to be “closer” to its target level of 2% next spring. The Monetary Policy Committee said that current evidence suggests that borrowing costs will continue to fall next year.
However, in its new wording, the Monetary Policy Committee warned that as policy interest rates gradually approach the “neutral interest rate” — that is, a level that neither pushes up nor suppresses inflation — the decision on whether to continue to cut interest rates in the future will become more delicate and difficult to balance. In a statement, Bailey said: “We still think interest rates will gradually decline. But as we cut interest rates every time, how much we can cut in the future will become a decision that requires more careful balance.”
The minutes of the meeting suggest that the Bank of England may be nearing the end of the current cycle of interest rate cuts, and warned that its policy stance is no longer so restrictive, and that the extent to which monetary policy is relaxed next year will “depend on the evolution of inflation prospects.”
The British pound and 10-year British Treasury yields erased previous declines due to policy guidance given by the Bank of England. The yield on two-year Treasury bonds, which are most sensitive to interest rates, rose 3 basis points to 3.47%, and 10-year UK Treasury yields rose 2 basis points to 4.49%. The exchange rate of the British pound was generally stable against the US dollar, trading at around 1.3383.
When the Bank of England decided to cut interest rates, market concerns have gradually shifted from stubborn inflation to weakness in the economy and labor market. The Bank of England warned that gross domestic product (GDP) growth would stagnate in the fourth quarter, having previously predicted a 0.3% increase. However, the central bank added that the basic health of the economy had not changed, and indicated that corporate surveys showed signs of recovery after the budget was announced.
A series of economic data released over the past week and a relatively modest government budget were viewed by traders and economists as key factors contributing to Thursday's interest rate decision. Data released by the UK Office for National Statistics on Tuesday showed that the UK unemployment rate rose to its highest level in nearly five years, while wage growth slowed. According to reports, the unemployment rate rose to 5.1% in the three months up to October, up 0.1 percentage points from the previous value, the highest level since the beginning of 2021, which is in line with economists' expectations. Meanwhile, the average wage growth rate without bonuses fell slightly from 4.7% to 4.6%, the lowest level since the beginning of 2022. Among them, the private sector wage growth rate fell below 4% for the first time since 2020. Although these figures were slightly higher than expected, the November tax data showed that the number of registered employees fell by 38,000, which was more than expected.
Furthermore, according to data released on Wednesday, the CPI rose 3.2% year on year in November, the lowest level in eight months, lower than market expectations of 3.5% and the previous value of 3.6%. This was mainly due to falling prices for some food products such as cakes, cookies, and breakfast cereals.
It is worth mentioning that this interest rate decision also revealed serious differences within the Bank of England's monetary policy committee on interest rate prospects. The four hawkish interest rate makers all insisted against interest rate cuts, even though Catherine Mann (Catherine Mann) said that her vote to keep interest rates unchanged was “quite a difficult trade-off,” while Megan Greene (Megan Greene) acknowledged that the risk of inflation had skewed downward.
Among the five members supporting interest rate cuts, three, including Bailey, said they would continue to pay close attention to wage pressure. Two dovish commissioners — Swati Dhingra (Swati Dhingra) and Alan Taylor (Alan Taylor) — emphasized the downside risks to economic growth and inflation.
Bank of England easing may be nearing its end
Despite the Bank of England cutting interest rates as scheduled, policymakers will now face a difficult question — is the easing cycle, which began less than a year and a half, nearing the end? A recent estimate quoted by Bailey and many other indicators show that the UK's “neutral interest rate” level is within easy reach, and the current interest rate is only one to two interest rate cuts short of this level.
Although most members of the Bank of England's monetary policy committee have been unwilling to specify their neutral interest rate range, this concept has quietly become an important factor to consider in decision-making. The Monetary Policy Committee's key disagreement is how to balance Britain's high level of inflation with the continuing weakening job market. Since the beginning of the current easing cycle in August 2024, these two competing forces have made it difficult to advance interest rate cut decisions, and as policy interest rates approach a neutral level, future interest rate cuts will become more challenging.
The Bank of England suggests that inflation is at a downside risk, but the UK's inflation outlook is still being challenged. The fiscal austerity proposed by the Labor government in the fall budget did not eliminate inflationary stickiness; on the contrary, it may increase service inflation through cost transmission. A number of tax increases in the budget — such as the freezing of employers' national insurance thresholds, the tightening of the pension contribution tax system, and the reduction of corporate depreciation deductions — directly or indirectly increase the operating costs of enterprises. These cost pressures may be passed on to the prices of goods and services, which will further drive up core inflation, especially as the service sector accounts for more than 80% of the UK economy.
However, British Chancellor of the Exchequer Rachel Reeves (Rachel Reeves) defended her latest budget policy in her correspondence with Bailey. She said that the decision to freeze railway fares and prescription drug prices and reduce the annual energy bill of 150 pounds per household will reduce the inflation rate by 0.5 percentage points. She also said, “I know there's more work to be done.”
Paul Dales, UK's chief economist at KITU Macro, said earlier: “From now on, the threshold for every interest rate cut will be raised significantly. Despite the serious differences among the members of the committee, I can't help but speculate that the previous almost 'inertial' pace of interest rate cuts may come to an end.”
Economists surveyed expect the Bank of England's benchmark interest rate to fall to 3.25% in the second half of next year. In contrast, investors' expectations are more pessimistic, and they are betting that the final benchmark interest rate will stabilize at around 3.4%. This means that if the Bank of England cuts interest rates as scheduled this week, then policymakers will only have room to cut interest rates by 25 basis points once — if interest rates are cut further, they may face the risk of stimulating a rebound in inflation.