Financial markets are anticipating that the Bank of England might implement an interest rate cut during its first Monetary Policy Committee (MPC) meeting of 2025. This potential move has garnered attention as the Bank navigates evolving economic conditions and changing financial dynamics.
However, optimism for a second interest rate cut later in the year appears to be diminishing. Confidence in further reductions has cooled, reflecting uncertainties in the broader economic outlook and potential challenges that could arise.
Adding to the complexity, at least one major investment bank has expressed scepticism about the market’s longer-term projections. This divergence highlights differing interpretations of economic indicators and monetary policy trends.
The evolving expectations underscore the uncertain economic landscape as stakeholders analyse the Bank’s future decisions and their implications for financial markets and the economy at large.
What is the Bank of England Base Rate?
The UK’s base rate currently stands at 4.75%, following two reductions last year in August and November. This decision came after a tight vote by the Monetary Policy Committee (MPC) in December, with six members favouring holding rates steady amid persistent inflation in the services sector.
Concerns over persistent inflation have fuelled fears that the Bank of England may keep interest rates elevated for a prolonged period. This approach is placing considerable strain on individuals with high levels of debt and mortgage holders transitioning to more expensive fixed-rate deals as their current packages expire.
The latest inflation data for the 12 months leading to December 2024 reveals a Consumer Price Index (CPI) increase of 2.5%. While this figure is a notable improvement, it still surpasses the Bank of England’s 2% target, indicating ongoing price pressures within the economy.
The outlook for interest rates in 2025 remains uncertain. Recent turmoil in the UK gilt market has demonstrated how quickly economic anxieties and external factors—such as potential tariffs from a new Trump administration in the US—can influence bond yields and market stability.
If the Bank of England opts to lower rates during its next decision on Thursday, February 6, it could trigger a significant response in financial markets. Equity markets are likely to experience an upswing, while bond yields may see a notable decline, reflecting the broader impact of monetary policy shifts.
Will the Bank of England Cut Interest Rates?
The chances of an interest rate cut by the Bank of England on February 6 stand at an estimated 92%, according to interest rate swaps data. Despite this, no further cuts are currently expected in 2025. The data suggests a 49.8% probability of a cut in August, falling just below the 50% threshold that would indicate a likely change in rates.
Michael Field, Morningstar’s European Market Strategist, highlights the discrepancy between market pricing and investor sentiment. He notes, “It seems we have something of a conflict between what interest futures are pricing in—just 25bps cuts this year—and what investors are actually saying.” Field remains optimistic about a February rate cut, driven by the latest inflation figures, but cautions against overstating these minor changes. He adds, “With rates in the UK at 4.75%, that seems excessively high, particularly given how far inflation has already fallen from the peaks.”
A key contributor to this discussion is Goldman Sachs. The investment bank has suggested there could be as many as six interest rate cuts by the Bank of England by next spring. This forecast contrasts with the broader market’s more conservative expectations. Goldman Sachs’ December 2023 predictions were largely accurate, forecasting a 4.75% rate by year-end, though they misjudged the timing of cuts, which occurred in August and November rather than February and March as predicted.
Goldman Sachs’ hypothesis is supported by several economic factors, including the UK’s sluggish economic growth and the easing of the tight labour market. This shift means there are fewer job vacancies relative to the workforce, reducing employees’ bargaining power over wages and potentially alleviating upward wage pressures on inflation.
As the Bank of England’s next monetary policy decision approaches, the debate over rate cuts underscores the uncertain trajectory of the UK economy. Whether rates are adjusted as predicted, or the Bank adopts a more cautious stance, remains to be seen.
What Will Equities and Bonds Do if the Bank of England Cuts Rates?
If the Bank of England decides to cut rates next month, it is expected to spark optimism in equity markets, as such moves are typically seen as a positive step in the fight against inflation. Lower interest rates generally free up capital within the real economy, allowing for increased spending. This is often viewed favourably by businesses and investors alike, as it can signal a boost in economic activity.
However, there is a notable caveat to this scenario. February’s Monetary Policy Committee (MPC) meeting will coincide with the release of the quarterly Monetary Policy Report. This detailed report provides insights into the Bank’s expectations for the year ahead and is closely monitored by traders and investors for any indications of future monetary policy directions. As a result, its release is likely to have a significant impact on the markets.
The Bank of England’s most recent Monetary Policy Report, published in November 2024 alongside its last interest rate cut, offered some guidance on its intentions. At the time, the Bank stated that further rate reductions were on the table but would need to be approached cautiously. “If inflation remains low and stable, it’s likely that we will reduce interest rates further,” the Bank noted. However, it also warned, “We have to be careful not to cut interest rates too quickly or too much. High inflation has affected everyone, but it particularly hurts those who can least afford it.”
Should another rate cut occur, bond yields are likely to fall as a result. This is because bond prices are highly sensitive to changes in interest rates, with monetary policy playing a crucial role in determining demand for fixed-income securities. Lower interest rates often drive investors to seek higher returns elsewhere, which can push bond prices higher and, consequently, yields lower.
Currently, the yield on the UK’s 30-year gilt stands at approximately 5.12%. While yields have eased since the turbulent period that saw levels spike to highs not seen since 2008, they remain elevated compared to a year ago. This reflects ongoing uncertainty and the potential for further market adjustments in response to monetary policy changes.
One-Dimensional’ Bank of England’s Role in Question
The Bank of England (BoE) became independent from the government in 1997, following Tony Blair’s ascension to prime minister and Gordon Brown’s appointment as chancellor. This shift in policy meant that the Bank would now set interest rates without interference from central government officials in Whitehall. This model mirrors that of the US Federal Reserve, which operates independently of the White House when determining interest rates.
However, some commentators argue that the BoE’s model should be more similar to that of the Federal Reserve, particularly in light of the current political climate in the UK. While the Bank of England is focused solely on maintaining price stability, the Federal Reserve has a dual mandate: price stability and maximum employment. In an environment where Keir Starmer’s government has committed to boosting economic growth, some experts believe the UK should adopt a similar model to the Fed.
In light of the latest consumer confidence figures for the UK, which showed a significant decline in confidence regarding the state of the economy, Jamie Constable, chief market strategist at Singer Capital Markets, advocates for an immediate policy shift. He argues that the current focus on inflation alone is insufficient.
“Poor consumer confidence and flash purchasing manager indexes, which highlight companies raising prices and cutting jobs, point to a real need for the one-dimensional Bank of England inflation mandate to be revised to include jobs and de facto growth, as per the Federal Reserve,” Constable explains.
He goes on to suggest that if the government is truly serious about stimulating growth, it must show a better understanding of how the economy operates and how incentives work. Constable believes this change should be made promptly to reflect a more holistic approach to economic management.