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The Bank of England has warned that stubborn inflation will prevent it from cutting interest rates quickly, as it kept monetary policy on hold despite downgrading growth prospects.
In a six-to-three decision on Thursday, the Monetary Policy Committee maintained its benchmark rate at 4.75 per cent, with a majority expressing concern that recent increases in wages and prices had “added to the risk of inflation persistence”.
Its move came even as the BoE predicted zero growth in the final quarter of the year — a downgrade from its previous forecast of 0.3 per cent — adding to the economic problems facing chancellor Rachel Reeves.
In a reference to Budget measures that increased employers’ taxes and the national living wage, the bank noted “significant uncertainty around how the economy might respond to higher overall costs of employment”.
“Most indicators of UK near-term activity have declined,” it added on Thursday.
“We think a gradual approach to future interest rate cuts remains right,” said Andrew Bailey, BoE governor. “But with the heightened uncertainty in the economy, we can’t commit to when or by how much we will cut rates in the coming year.”
Traders expect the BoE to make two quarter-point rate cuts next year — the same as immediately before Thursday’s decision. That compares with the four the market expected as recently as October.
Rob Wood, UK economist at Pantheon Macroeconomics, said the minutes of the MPC meeting were “cautious and therefore more hawkish than that six-to-three headline would suggest”.
He said inflation was likely to rise above 3 per cent in the spring, “with highly visible price rises that could destabilise inflation expectations that are already above average and rising”.
A majority of the MPC said that “recent developments added to the argument” for gradual rather than rapid rate cuts, warning of “the potential trade-off between more persistent inflationary pressures and greater weakness in output and employment”.
The BoE’s downbeat language came a day after the US Federal Reserve signalled it would slow the pace of its rate cuts next year as it manages a more buoyant economy alongside signs of persistent inflation.
It also followed data this week that showed that UK inflation rose to 2.6 per cent last month, from 2.3 per cent in October.
But the three MPC members favouring a quarter-point reduction — deputy governor Dave Ramsden, Alan Taylor and Swati Dhingra — cited “sluggish demand” and a weaker labour market.
The BoE added that risks to global growth and inflation from geopolitical tensions and trade policy uncertainty had “increased materially” — an apparent reference to US president-elect Donald Trump’s plans to increase tariffs on imports to the US.
Reeves’ allies said Britain faced a “very challenging period” but maintained the chancellor was pushing through long-term reforms in areas such as pensions and planning to boost growth.
But, with inflation rising, growth stalling and confidence among employers falling, the chancellor enters 2025 with growing uncertainty over her fiscal plans. She has just £10bn set aside as a buffer against her own borrowing rules.
If growth underperforms and interest costs remain higher than expected, Reeves could be forced to seek politically painful new spending cuts in the spring — or tax rises in the autumn — to make her fiscal plans add up.
Sterling and gilt yields fell slightly after the decision to hold rates, as investors focused on the larger-than-expected group of doves calling for immediate rate reductions.
The pound dipped to $1.260 after the BoE’s announcement, though it was still up 0.2 per cent on the day. The yield on rate-sensitive two-year government bonds edged downwards to 4.46 per cent.
The BoE cut rates by a quarter point at its previous meeting in November, but signalled at the time that another reduction was unlikely until 2025. It has cut rates twice in 2024 and is due to announce its next rates decision on February.
