Bank of England Cuts Rates, But Sees Higher Inflation After Budget

The Bank of England (BoE) cut interest rates on Thursday for only the second time since 2020, but signaled that future reductions would be gradual, citing the impact of the new government's first budget, reports Reuters.

The Monetary Policy Committee voted 8-1 to lower rates to 4.75% from 5%, with only Catherine Mann favoring a hold. Sterling rose after the announcement, but investor expectations for rate cuts in 2025 remained largely unchanged.

BoE Governor Andrew Bailey acknowledged the need for cautious rate reductions, stating, "we can't cut interest rates too quickly or by too much," but added, "If the economy evolves as we expect it's likely that interest rates will continue to fall gradually from here."

Bailey indicated that the BoE might accelerate rate cuts if inflation continued to undershoot forecasts. The central bank had begun cutting borrowing costs in August after observing easing inflation pressures but emphasized a cautious approach. In September, they opted to hold rates steady.

The recent budget, characterized by significant borrowing and spending, prompted investors to revise their expectations for the pace of future rate cuts. However, Bailey asserted that the budget's impact on the overall rate-cutting path would not be "particularly different."

The BoE projected that the government's plans would increase inflation by almost half a percentage point at its peak in just over two years, delaying the return of inflation to the central bank's 2% target by a year.

The budget is also anticipated to boost the UK economy by about 0.75% next year but have a negligible effect on annual growth rates in the next two to three years, according to the BoE.

Finance Minister Rachel Reeves and Prime Minister Keir Starmer, elected in July, have prioritized robust economic growth in their policies.

Reeves welcomed the rate cut, stating that it would benefit families.

"Despite big spending increases in last week's UK budget, the Bank of England has signalled that it's not a game changer for future interest rate cuts," said ING economist James Smith, to Reuters. "We think the Bank will keep rates on hold in December but accelerate the pace of cuts from February onwards."

While the BoE's statement did not directly address Donald Trump's US election victory, which has led to a decrease in expectations of aggressive Fed rate cuts, Bailey indicated that he would closely monitor Trump's trade policies. The president-elect has proposed significant import tariffs.

"The upward pressure on inflation from the budget and growing global risks, including possible new U.S. tariffs, could mean that policy is loosened more modestly," said Suren Thiru, economics director at the Institute of Chartered Accountants in England and Wales, to Reuters.

The BoE forecasts inflation to 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 its 2% target in mid-2027.

Government decisions to increase bus fares, raise value-added tax on private school fees, and increase employers' social security contributions are likely to contribute to higher inflation.

The BoE's growth and inflation forecasts, while incorporating the impact of increased spending and taxes, do not account for the surge in market borrowing costs since the budget. If these higher market interest rates were factored in, the outlook for inflation and growth would likely be slightly lower.