The Bank of England cut borrowing costs for the second time this year, but it stopped short of signaling faster easing, warning that the budget could drive up inflation by as much as half a percentage point.
Eight members of the Monetary Policy Committee led by Governor Andrew Bailey voted to lower the benchmark interest rate by a quarter point to 4.75%. Catherine Mann, one of its external officials, was the lone dissenter, preferring to hold at 5%. The outcome was widely anticipated by economists.
"We need to make sure inflation stays close to target, so we can’t cut interest rates too quickly or by too much,” Bailey said in a statement Nov. 7 in London. “But if the economy evolves as we expect, it’s likely that interest rates will continue to fall gradually from here.”
The pound edged up after the decision while 2-year U.K. bonds held gains. Traders are fully pricing in two more quarter-point reductions by the end of next year, with just under a 50% chance of another.
The BOE’s path to further easing has been complicated both by Chancellor of the Exchequer Rachel Reeves’ Oct. 30 budget and the election of Donald Trump as U.S. president. The U.K. now plans a £70 billion ($90.4 billion) a year spending binge, almost half of which is financed by borrowing. Trump is threatening higher tariffs in a new global trade war.
J Sainsbury, a U.K. grocery store chain, warned that higher payroll taxes and wage increases planned by the Labour government could bring inflation back to British supermarket shelves. Britain’s second-largest grocer expects to take a £140 million hit from the spending plan and CEO Simon Roberts said the company didn’t have the capacity to absorb all of it.
Bond markets have also taken fright, with U.K. government borrowing costs hitting one-year highs since the budget was released. That stirred memories of the financial meltdown triggered in 2022 when then-Prime Minister Liz Truss’ £45 billion of unfunded tax cuts rattled investors.
The market repricing was “orderly,” BOE Deputy Governor Dave Ramsden observed at a news conference on the rate decision.
The recent large market moves meant that the BOE based its forecasts on a lower path for borrowing costs than currently priced. Using an implied outlook for interest rates to fall to 3.7% by the end of next year and remain there, officials see inflation above the 2% target, at 2.2% after two years. It then slows below the goal to 1.8% in the course of 2027.
Before the decision, markets saw rates remaining almost half a percentage point higher, which would imply a sharper slowdown in consumer price growth, and potentially, greater BOE action.
Even so, the committee retained its guidance that “based on the evolving evidence, a gradual approach to removing policy restraint remained appropriate.”
The tone of the BOE decision convinced traders that this was the last rate cut of the year. Money markets now expect about a 15% chance of another quarter-point reduction in December, from 25% before the decision and from about 70% at the start of last month.
Investors are also forecasting less easing next year, with markets fully pricing two cuts with a third hanging in the balance. The repricing boosted the pound, with sterling up 0.5% to $1.2937.
The BOE reduction precedes a step of the same size seen likely from the Federal Reserve later on Nov. 7, in the first U.S. rate decision since Trump’s victory. Earlier in the day, Sweden’s Riksbank ramped up easing with a half-point cut, while Norwegian officials kept borrowing costs unchanged.
Policymakers voted Nov. 6 shortly after the results of the U.S. election became clear, but the account of their deliberations makes only limited reference to the risks of a trade war.
There are “upside risks to goods and commodity prices from greater trade fragmentation and adverse geopolitical developments, including from events in the Middle East,” the MPC minutes said.
Bailey, questioned by reporters on Trump’s election win, insisted that “we’re not going to respond to anything” to do with prospective U.S. policies.
“We look forward to working with the new U.S. administration,” he said. “We worked with the previous Trump administration, we work with the current administration. That’s what we do — we do it without any, if you like, sort of presumptions, and we will do that constructively.”
Reeves’ budget caused further uncertainty. While the chancellor herself described the rate cut as “welcome news” for homeowners and businesses, emphasizing that borrowing costs are on a downward path, BOE officials are more guarded about the impact of her budget.
BOE officials will be watching to see how much is taken in squeezed profit margins, how much in lower pay and how much in higher prices. The central bank added that some of the recent steep fall in services inflation was “expected to unwind.” The labor market “continues to loosen, though it appears relatively tight by historical standards,” it added.
“The MPC is now dealing with two new inflation shocks: Mr. Trump and the budget,” said Rob Wood, chief U.K. economist at Pantheon Macroeconomics and a former BOE official, in a report. The result “means more hawkish interest rate policy.”
