Updated: BoE Interest Rate Decision 4.50% as Expected

Comment:

Bank of England Cuts Interest Rates but Signals Limited Further Easing

The expected interest rate cut by the Bank of England will have a mixed impact on the pound and the FTSE 100 index. On one hand, lower rates typically weaken the currency, which could lead to a depreciation of the pound. However, signaling limited future easing and high inflation may keep pressure on the currency. On the other hand, the FTSE 100, which includes many export-oriented companies, could benefit from a weaker pound, making British goods more competitive on the global market. Nevertheless, weaker economic growth and a slow recovery may limit the index’s upside potential.

The Monetary Policy Committee (MPC) of the Bank of England voted to cut interest rates to a 19-month low but maintained a hawkish tone, signaling that only two more cuts are needed to bring inflation back to the 2% target.

In a blow to Chancellor Rachel Reeves, the BOE warned that inflation would rise “quite sharply,” peaking at 3.7% later this year, compared to the previous forecast of 2.8%, while lowering growth and economic capacity projections in the short term.

The MPC cut its key interest rate by a quarter point to 4.5%—the lowest level since June 2023—providing relief for more than half a million homeowners with five-year fixed mortgage deals expiring in 2025. Seven out of nine members voted for a quarter-point cut, but two external members—Swati Dhingra and Catherine Mann—pushed for a half-point reduction. This was the first time Mann, who has an “activist” approach, voted for a cut.

“It will be welcomed by many that we have been able to cut interest rates again,” said Governor Andrew Bailey. “We will closely monitor the UK economy and global developments, taking a gradual and cautious approach to future cuts.”

However, the MPC added the word “cautious” to its key guidance, indicating that risks are now two-sided. “A gradual and cautious approach to further removing restrictive monetary policy is appropriate,” the MPC minutes stated. “There are uncertainties surrounding demand and supply dynamics in the economy, which could have implications for monetary policy.”

Economists had expected an 8-1 split, with Mann remaining a holdout on rates, so the vote was surprisingly dovish. However, the updated forecasts in the Monetary Policy Report painted a slightly more aggressive picture.

Inflation Will Stay Higher for Longer

The market scenario for interest rates used in the forecasts includes only two more cuts over the next three years, stabilizing monetary policy at 4%. Only one more cut is fully priced in for this year—to 4.25%. Under this scenario, inflation returns to target in the fourth quarter of 2027.

This means monetary policy needs to remain much tighter than the four cuts this year that the BOE signaled in November and that Bailey supported in December. The blame for higher inflation mainly falls on rising costs for energy, water, and regulated prices such as bus fares.

Another factor behind the shift was the downgrade of the bank’s estimate of the UK’s growth capacity, making faster growth more inflationary. The BOE lowered its forecast for potential economic growth to 0.75% for this year—half of its previous estimate—but expects growth to recover to 1.5% by 2026. The slow growth was linked to weak productivity and rising costs for the National Health Service, which could further exacerbate the situation.

Weak Economic Outlook

The BOE’s economic forecast presents a grim backdrop for Reeves, who has been managing an economic downturn since the Labour Party won the parliamentary elections in July last year. The BOE believes the economy contracted by 0.1% in the last quarter of 2024, which includes Reeves’ October 30 budget that raised taxes. The expected growth for the first quarter of 2025 is just 0.1%.

The growth forecast for this year was halved to 0.75%, but a recovery to 1.5% is expected in 2026 and 2027, compared to the previous 1.25% projection for those years. The BOE stated that its forecast “is not contingent on changes in global tariffs”, but a trade war could weigh on economic growth by delaying investment and hiring decisions.

Reeves’ fiscal policies, including a £26 billion increase in employer National Insurance contributions, are putting pressure on short-term economic prospects. According to the BOE, business confidence remains weak, and if this trend continues, growth could be even lower than expected.

So far, there have been no substantial changes in the BOE’s forecasts following Reeves’ latest plans to stimulate growth through regulatory easing and acceleration of infrastructure projects.

BoE Interest Rate Decision (Feb)
Actual: 4.50%
Forecast: 4.50%
Previous: 4.75%