The UK’s central bank cut interest rates on Thursday for only the second time since 2020 — but the Bank of England said future reductions are likely to be gradual amid fears of higher inflation after the new UK Labour government’s first budget.
The central bank’s Monetary Policy Committee voted 8-1 to cut interest rates to 4.75% from 5%.
Catherine Mann dissented, preferring to keep rates on hold.
“We need to make sure inflation stays close to target, so we can’t cut interest rates too quickly or by too much,” the central bank’s governor Andrew Bailey said in a statement.
“But if the economy evolves as we expect, it’s likely that interest rates will continue to fall gradually from here.”
REACTION:
Luke Bartholomew, Deputy Chief Economist, Abrdn: “A cut from the Bank of England was always extremely likely today. But the outlook for interest rates from here has become more clouded following both the Budget and the US presidential outcome.
“The fiscal stimulus announced in the Budget puts upward pressure on growth and inflation in the near term, which will keep rates a bit higher than they otherwise would have been.
“Meanwhile the stronger dollar and higher US yields following the US election result represents a challenge for the Bank, as a weaker pound may lead to more imported inflation pressure, while higher US borrowing costs risks pulling UK market rates higher than policymakers want.
“On balance, we expect the Bank’s gradual pace of easing to continue, with quarterly 25bps rate cuts through next year but there are now risks in either direction, which could keep the rates market volatile.”
Daniel Mahoney, UK Economist at Handelsbanken: “The BoE’s latest forecast re-enforces the OBR’s assessment that the UK’s expansionary Budget will have a notable inflationary impact.
“The Budget is expected to boost y-o-y CPI by just under 0.5pp at the peak and the BoE’s medium-term inflation forecasts (based on market expectations for interest rates) have increased since their previous inflation report: their current forecast, for example, is no longer expecting UK inflation to be at or below target in 2026.
“Growth forecasts by the BoE potentially spell out more trouble for Chancellor Rachel Reeves, with its projections for medium-term GDP growth undershooting the OBR’s assumptions.
“This is significant given the OBR predicted that Reeves only had just over a 50% chance of meeting her fiscal targets, and since then gilt yields have risen and the US election results have a potential downside risk to growth in light of prospective tariffs being implemented …
“Even before the UK Budget and the US election results, we continued to believe that UK inflation may continue to show signs of persistence. The labour market, in particular, remains a source of concern given a variety of metrics continue to suggest relative tightness compared to historic norms, and the BoE’s latest assessment highlights continuing uncertainty around the outlook.
“Following an inflationary Budget and the prospect of a further inflationary impulse from developments in the US, we have revised our interest rate forecast and are now predicting fewer interest rate cuts over the coming 18 months. Our current projection is for there to be only a further four interest rate cuts between now and 2026, with rates settling at 3.75%.”
Nicholas Hyett, Investment Manager at Wealth Club: “After two weeks of volatile political theatre the Bank’s decision to stick to the script and cut rates is very welcome. Inflation remains moderate and economic growth positive, if anaemic.
“The Chancellor will be pretty pleased with the Bank’s assessment of the last week’s budget. Yes it will drive a modest pickup in inflation, but GDP is also expected to be around 0.75% higher next year than it would otherwise have been.
“The big unknown is the future path of wage growth. A relatively tight labour market has driven sticky service inflation, but now seems to be easing. The problem is that rises to the minimum wage and National Insurance contributions in the Budget have the potential to keep service inflation higher going forwards if employers pass those costs on.
“All in all, this is far from a showstopping set of MPC minutes – it feels like the Bank is happy to wait in the wings and see how the politics plays out.”
Douglas Grant, Group CEO of Manx Financial Group: “The Bank of England’s decision to lower interest rates to their lowest level since last June aligns with positive news that UK inflation has fallen below the 2% target for the first time in over three years.
“This policy shift, alongside controversial Autumn Budget fiscal plans, provides a potential boost for UK investments after a period of economic stagnation. However, high input costs and possible inflationary pressures from the Chancellor’s measures mean that businesses must adapt their lending strategies to stay resilient in a still uncertain market.
“Recent research from Manx Financial Group shows that nearly a third of UK SMEs have paused or reduced operations due to financial constraints—an improvement from 40% in 2023 but still significant, with around 10% of SMEs struggling to access external finance.
“Given SMEs’ role in driving growth, employment, and innovation, the Labour Government must foster a supportive lending environment for their resilience and expansion. Both traditional and alternative lenders are key to this, as inadequate financing could hinder recovery amid rising taxes, geopolitical tensions, and cost-of-living pressures.
“This period of monetary easing offers SMEs a crucial opportunity to secure affordable credit and build resilience as the fiscal and economic landscape evolves.”
Susannah Streeter, head of money and markets, Hargreaves Lansdown: “Policymakers haven’t rocked the unsteady boat and have opted for an interest rate cut of 0.25%. At a time of deep uncertainty about where inflation will head next, this decision will help provide some reassurance. But the waters ahead look murkier as the implications of Trump heading to the White House for a second term collide with the impact of the UK Budget.
“The Bank is expecting the Budget to boost inflation by just under half of a percentage point, due to direct and indirect effects of Rachel Reeves policies.
“Fresh nervousness has been sweeping bond markets amid fears that Trump’s policies look set to increase inflationary pressures and swell the US deficit even further, with knock-on effects expected for the UK economy. UK gilt yields were already jittery following the big borrowing plan outlined in the UK Budget.
“There are concerns that the increase in employers National Insurance contributions could be passed on in the form of higher prices of goods and services. Now these worries have been exacerbated by US Treasury movements and the knock-on effects of Trump’s policies.
“There is also concern that his trade policies could hold back Britain’s economic growth. The fear of a stagflation scenario emerging appears once again to be stalling markets and it’s going to make decisions at the Bank even more tricky in the months ahead.
“Financial markets are now expecting the Bank to go even slower on rate cuts than they were before Trump’s win, with an implied rate of 4.1% forecast for December next year.”
Lindsay James, investment strategist at Quilter Investors: “This decision comes as inflation has eased, with headline inflation dropping to 1.7% in September from 2.2% in August, and core inflation falling to 3.2% from 3.6%. Despite this benign inflationary backdrop, the UK economy has experienced weak growth over the summer, and pressures on employers have increased, even as unemployment remains low.
“Interestingly, long-term bond yields have risen recently, and the market has adjusted to price in fewer rate cuts despite the economic conditions. This shift is driven by concerns over the Labour government’s additional borrowing and changes to fiscal rules, which, although sensible, are challenging to implement amid current pressures on public finances.
“Additionally, rising bond yields in the US, fuelled by fears that inflation will remain above target while the economy stays strong, have influenced this trend. Donald Trump’s aggressive spending plans, projected by the Congressional Budget Office to increase US debt to GDP to 143% by 2034, have further compounded these concerns.
“The divergence between the Bank of England and the Federal Reserve poses challenges. If the Bank of England cuts rates more aggressively than the Fed, it could lead to a weaker pound, which would be inflationary by raising import costs for essential items like food and energy, potentially dampening consumer spending. However, it could also boost UK exports and attract increased US interest in UK mergers and acquisitions.
“With expectations for UK rate cuts now being scaled back, and rates not expected to fall below 4% in 2025, investors would be well advised to lock in borrowing rates where possible. The influence of US monetary policy remains significant, with interest rates likely to stay higher for longer.”
Kathleen Brooks, research director at XTB: “The pound is benefitting from the BOE’s claim that it will continue with ‘gradual’ cuts to interest rates going forward, and implied interest rates for the UK have moved higher. The implied interest rate for June 2025 is 4.19%, this was 4.15% on Wednesday. This could add some upward pressure to GBP, and GBP is one of the strongest performers in the G10 FX space on Thursday.
“The FX market appears to be running with the slightly hawkish tone to the BOE statement and the change to growth and CPI forecasts included in the BOE’s Monetary Policy Report.
“In the longer term we still think that the dollar is the King of the FX space after Trump’s big victory in the US election. Due to the upside bias in USD, the pound may struggle to stay above $1.30 if it gets to this level on the back of today’s rally …
“This BOE meeting was never just about the rate cut, it was also about the Budget and the US election result. The BOE has adjusted its forecasts for growth and inflation on the back of last week’s Budget. The Budget is expected to add 0.75% to GDP next year, as the effects of the Budget are felt in the short term.
“The BOE also revised higher their inflation forecast on the back of the Budget by 0.5%. This is a notch higher than the OBR’s forecast for inflation. Overall, the BOE’s forecasts for the economic impacts from the Budget is inline with OBR forecasts. Regarding the rise in employer national insurance contributions, the BOE thinks that they will have a small downward impact on wages and a small upward increase in company level inflation …
“The BOE also released their longer-term forecasts for growth and inflation. The BOE now expects inflation to stay around the target 2% rate in the long term, back in August, inflation was expected to fall below target by Q3 2027. Growth expectations have also shifted a little. This year’s growth forecast has been revised lower to 1% from 1.25%, 2025’s GDP forecast has been revised higher to 1.75% from 1.5% and the forecast for 2026 has remained steady at 1.25%. In the longer term, the BOE forecasts that UK growth will be lower than the US and the Eurozone. This could add pressure to Chancellor Rachel Reeves …
“Andrew Bailey said that it was too early to assess the economic impact of Donald Trump’s win in the US presidential election this week. However, he said that the UK will be exposed to global trade shocks since it is an open economy. He also said that the BOE will be watching closely for signs of ‘fragmentation’ in global trade on the back of potential Trump tariffs. From the BOE’s perspective, the win for Trump makes its job harder, however, it hasn’t altered the growth outlook too much.
“This doesn’t mean that the UK’s growth outlook will not be adversely impacted from a Trump presidency if he sticks to his campaign pledge that puts America first and slaps punitive tariffs on UK goods. The US is the UK’s largest export market for manufactured goods, and 25% of all exports go to the US, so the BOE is right to be worried and growth forecasts could be updated on the back of future US economic policy …
“Today’s BOE meeting has caused a shift in UK rate expectations. There is now a 23% chance of a rate cut next month, this had been 32% on Wednesday. The BOE is next expected to cut in February, and we expect them to stick to the pattern of changing rates at meetings where they release their Monetary Policy Reports. There is still just over 3 rate cuts priced in by September 2025, which supports that assessment that the BOE only cuts rates when the Monetary Policy Report is released.
“Overall, this was a cautious meeting from the BOE, who have had to factor in big events like the Budget and the economic implications of the next US president into their forecasts. This is a tricky task, and we think that their forecasts are subject to change. Also, this BOE meeting raises the prospect of only gradual rate cuts, and the chance that rates may not be cut by as much as expected. This is boosting the pound on Thursday, but a longer term move above $1.30 in GBP/USD is a tough ask this week.”
Ed Hutchings, Head of Rates at Aviva Investors said: “In line with market expectations the Bank of England cut interest rates today, however it seems the path as to what speed and to what extent is somewhat unclear at this stage.
“Whilst a December cut is most likely off the table for now, this should not prevent further cuts going forward, the employment and inflationary backdrop should determine this.
“The patience in waiting until early in 2025 should allow the Bank enough time to decipher what is warranted and for now a tentative and gradual approach is preferred.
“As previously stated however, and by the Governor Bailey himself, the Bank could become ‘more aggressive’ in their cutting cycle if they deem the conditions right, only time will tell on this.”