The Bank of England (BoE) is widely expected to proceed with a second interest rate cut this year, even though recent announcements from Chancellor Rachel Reeves’ Budget are likely to spur demand in the short term. Analysts believe that the BoE’s focus remains on the bigger picture, specifically aiming to bring down inflation sustainably over the longer term, rather than reacting to temporary demand shifts. This approach is reflected in the anticipation of a measured reduction in rates, intended to gradually balance economic growth with price stability.
On Thursday, the BoE’s Monetary Policy Committee (MPC) will reveal its latest decision on interest rates, with many economists, as per a Reuters survey, predicting a quarter-point cut, bringing the rate down to 4.75%. Traders were placing a high probability—almost 90%—on a reduction following the unexpected cut in August, which marked the first rate drop in over four years. In contrast, in their September meeting, MPC members opted to keep the rate steady at 5%, emphasising a cautious approach amidst ongoing inflation concerns.
This week’s economic outlook has further shifted following Reeves’ Budget, which introduced significant increases in public borrowing and government spending. The ambitious fiscal policies outlined by Reeves have prompted financial markets to re-evaluate the path of interest rates in the near term, given the additional government spending could fuel inflationary pressures. The chancellor’s statement marked a significant fiscal shift, injecting more funds into public services and infrastructure, potentially adding momentum to the UK economy but also creating new challenges for inflation management.
The Office for Budget Responsibility (OBR) has also weighed in on this dynamic, indicating that the scale of what they termed “discretionary fiscal easing” could lead to a slower pace of interest rate reductions than initially expected. The OBR suggests that the added public spending might mitigate the speed at which interest rates can be lowered, given the likelihood of increased demand from consumers and businesses.
In light of these developments, the BoE is likely to walk a fine line, balancing the need to support growth through lower rates while ensuring inflation remains on a downward trajectory. This balancing act reflects the broader challenges of managing an economy under fiscal expansion, with the bank needing to adapt its strategy in response to both fiscal and market changes.
Economists suggest that while the near-term stimulus introduced in the Budget has led to slightly higher inflation forecasts from the Office for Budget Responsibility (OBR), it’s unlikely to be substantial enough to prevent a much-anticipated interest rate cut on Thursday. Analysts maintain that the BoE’s focus remains on its broader economic targets rather than being swayed by short-term fiscal changes, even if inflation does temporarily edge up.
The outlook for further rate cuts beyond this, however, remains less certain. Governor Andrew Bailey is not expected to signal any further reductions by the end of the year, as the central bank assesses longer-term economic indicators and risks. Jens Larsen, an economist at Eurasia Group, believes policymakers will go ahead with the cut, stating, “They will cut almost for sure.” He added that while inflation might experience a slight uptick in the near term, the Budget doesn’t drastically alter the BoE’s view on the economy’s direction.
The recent data on inflation presents a cautiously optimistic picture. In September, headline inflation fell to 1.7%, marking the first time it has dipped below the 2% target since April 2021. Additionally, the growth rate of services prices dropped from 5.6% to 4.9%, suggesting a broader easing of inflationary pressures in some sectors.
In response to these developments, Bailey expressed optimism at a conference in Washington, DC, on 23rd October, noting that inflation was slowing more quickly than anticipated. He described the situation as a “good story” for the economy, hinting that inflationary pressures might ease in line with the BoE’s objectives. This shift, combined with the anticipated rate cut, may offer more stable conditions for the UK economy in the months ahead.
However, Bailey also highlighted the need for more consistent signs of easing in services inflation, emphasising its significance as a key indicator of domestic price pressures. Some economists took this as a note of caution, suggesting that the Bank of England may not commit to rate cuts at every upcoming meeting, as previously anticipated. This cautious approach reflects the Bank’s need to balance short-term policy actions with long-term stability, especially in light of recent economic shifts.
Rachel Reeves’ Budget announcement came as a surprise to markets, introducing a far more extensive fiscal loosening than many investors had expected. Her Budget significantly raised planned spending for the NHS and other government sectors, marking a notable increase in government expenditure for the coming year. Additionally, the Budget outlined an average increase in borrowing by £28 billion annually for the remainder of the current parliamentary term. This large fiscal stimulus led to swift market reactions and renewed discussions about the potential impacts on inflation and economic stability.
The unexpected scale of Reeves’ spending plans prompted a reassessment among financial analysts. In its report, the Office for Budget Responsibility (OBR) underscored this unexpectedly high level of fiscal loosening, noting that it was “unlikely to have been anticipated by market participants at this time.” The OBR’s analysis suggested that the Budget could add pressure to inflation and economic growth forecasts, pushing the BoE to maintain a cautious stance on rate adjustments.
In response to the Budget, the OBR also adjusted its forecast for the BoE’s interest rates and government bond yields, both rising by a quarter percentage point across the next five years. This recalibration reflects the fiscal watchdog’s expectation that the larger fiscal package could lead to persistent inflationary pressures, influencing the BoE’s approach to future rate cuts.
Bailey’s cautious remarks and the OBR’s revisions indicate a complex economic outlook, with fiscal stimulus measures likely to influence monetary policy decisions. As the BoE navigates these developments, its decisions will likely hinge on balancing immediate economic needs with long-term inflation control.
The Office for Budget Responsibility (OBR) recently revised its GDP forecasts for both this year and the next, reflecting a modestly optimistic outlook. Additionally, it projected that consumer price inflation would edge up slightly, from 2.5 per cent this year to 2.6 per cent in 2025. This significant increase in government borrowing and spending resulted in a temporary decline in UK government bond prices, with the 10-year gilt yield briefly climbing above 4.5 per cent on Thursday. However, yields later moderated, as yields move inversely to bond prices.
Despite the increase in bond yields, official data on wages and prices showed signs of continued easing, which many economists believe strengthens the case for an interest rate cut by the Bank of England on Thursday. The OBR, while raising its GDP forecasts for the near term, also adjusted its growth expectations for the later part of this parliamentary term, indicating a cautious approach to future economic conditions.
The Consumer Price Index (CPI) inflation averaged at 2 per cent in the third quarter, which was about 0.3 percentage points lower than the Bank of England had forecasted. Services prices, too, have come in below expectations, indicating that inflation pressures may be receding faster than anticipated.
According to George Buckley, an economist at financial services firm Nomura, these inflation developments give the Bank of England more leeway for rate cuts. Buckley remarked, “The bank finds itself with room to cut rates,” and he anticipates that the Bank will continue reducing rates on a quarterly basis throughout next year.
This anticipated series of rate cuts suggests that the Bank of England may prioritise fostering economic growth while keeping inflation within its targeted range. If inflation remains stable, the Bank’s rate adjustments could provide much-needed support to the UK’s economic recovery.