THE BANK of England (BoE) is expected to lower interest rates on Thursday, marking only the second such cut since 2020. Investors, however, are watching closely to see if the BoE signals its future approach in light of the government’s latest budget, which is expected to raise inflation.
The BoE has had almost a week to assess new tax and spending plans presented by finance minister Rachel Reeves. According to the Office for Budget Responsibility (OBR), the budget is projected to increase both inflation and economic growth in 2025, with consumer prices expected to rise by 2.6 per cent—significantly above the BoE’s 2 per cent target.
This inflation outlook has led investors to reduce expectations for frequent rate cuts next year. Additionally, uncertainty surrounds the economic stance of US president-elect Donald Trump, who has stated intentions to impose tariffs on imports from all countries. However, BoE Governor Andrew Bailey and his team are not expected to provide detailed comments on the US election outcome, as they had limited time to evaluate its implications.
Rate cut to 4.75 per cent expected
A Reuters poll of 72 economists anticipates that the BoE will reduce the Bank Rate to 4.75 per cent from 5 per cent on Thursday, with financial markets on Wednesday indicating a 97 per cent chance of such a decision. Market projections suggest two to three further rate cuts by the end of 2025, compared to nearly four projected before Reeves’ budget announcement. By contrast, the European Central Bank is expected to make more than five cuts within the same timeframe.
"The budget won't change the Bank's decision to cut rates again this week," said James Smith, a developed markets economist at ING. "But it does question our long-held view that rate cuts will speed up from now on," he added, noting the potential for a pause in rate changes by December.
Smith also highlighted that it remains unclear if the BoE’s projections will fully incorporate Reeves’ budget or appear only in the minutes of the Monetary Policy Committee meeting. The BoE typically finalises economic forecasts a week prior to voting on interest rates, coinciding with the budget’s release.
Following the OBR's budget assessment, British government bond prices fell, with the analysis showing Reeves narrowly meeting her fiscal rules and forecasting higher Bank Rates and bond yields. Most economists predict Thursday’s rate cut, though they anticipate a pause at the December meeting due to the updated inflation outlook.
"It is customary for the BoE to brush off changes in fiscal policy, but it would have to be tone-deaf to do that this time around," said Berenberg Bank economist Andrew Wishart. "The BoE should highlight fiscal policy as a reason to stick to 'a gradual approach to removing policy restraint': read one cut per quarter."
(With inputs from Reuters)
