Bank of England Likely to Cut Interest Rates

By Andy Bruce

(Reuters) – The Bank of England (BoE) is expected to cut interest rates next week, potentially leading investors to anticipate quicker reductions as the economy stagnates.

Economists polled by Reuters unanimously foresee a decrease in the BoE’s benchmark rate to 4.5%, down from 4.75%, on February 6. The BoE will also update its economic growth and inflation forecasts at that time. Investors currently believe there is nearly a 90% chance of a rate cut next week.

Since the last projections were made in November, the economy has experienced stagnation, with key inflation measures decreasing last month even as wage growth saw an unexpected rise.

Due to the mixed economic signals, investors are likely to be attentive to any shifts in the Monetary Policy Committee’s outlook. In December, six members voted to maintain rates while three supported a quarter-point cut.

Rate-setters may provide early guidance on a crucial aspect of inflation: the potential response from employers to the government’s October 30 budget, which imposes significant payroll tax increases starting in April.

On Wednesday, financial markets anticipated nearly three quarter-point BoE rate cuts this year, compared to less than two projected in early January.

Shifting US Rate Expectations

U.S. rate expectations, influenced by uncertainty surrounding Britain’s public finances since President Donald Trump’s inauguration, have triggered a sell-off. Finance Minister Rachel Reeves indicated she would ensure compliance with fiscal rules if necessary, likely hoping for a dovish stance from the BoE.

The increase in government borrowing costs since the budget could complicate efforts to adhere to fiscal rules, possibly resulting in tax increases or spending reductions.

Market expectations for BoE rate cuts might be more modest than the committee would prefer, especially with worries about a weak economy and deteriorating eurozone conditions.

The European Central Bank (ECB) has already lowered rates four times since mid-2024, contrasting with the BoE’s two reductions, and is poised for a fifth cut on Thursday.

Jane Foley, senior FX strategist at Rabobank, noted that while a dovish BoE statement may keep the pound weak in the short term, it would also reassure investors and the business sector.

MPC Members’ Comments

Public comments from MPC members have been sparse this year, but those who have spoken have generally leaned towards supporting lower rates. External member Alan Taylor mentioned the necessity of rate cuts in his first speech on January 15, projecting four reductions in 2025.

Deputy Governor Sarah Breeden noted on January 9 that economic data justifies the BoE’s gradual rate cut message, but timing remains uncertain.

Short-term market interest rates have decreased in recent weeks, but they remain significantly higher for longer-term horizons compared to the rates reflected in the BoE’s November forecasts. MPC members might consider current financial conditions as overly restrictive, risking inflation falling further below target in the coming years.

Philip Shaw, chief economist at Investec, stated that weak economic growth complicates the ability of companies to pass tax hike costs onto consumers, potentially enabling the Bank of England to overlook near-term inflation rises and implement more rate cuts than the market currently expects.

A recent business survey indicated that employees are likely to experience slower wage growth as a consequence of these economic pressures.