Expectations are high that the Bank of England will lower interest rates at its meeting next Thursday, with markets pricing in a 90% chance of a cut. Despite concerns over wage growth and inflationary pressures from Budget measures, weakening economic signals suggest the Bank may opt to ease rates.
Laith Khalaf, head of investment analysis at AJ Bell, said: “This will be the first interest rate decision from the Bank of England in 2025, and chances are we’re going to start the year off with a cut to base rate. Economic signals have been weak and services inflation has fallen back substantially since the last meeting of the MPC in December, at which point three members of the committee already voted for a cut to 4.5%. The market is currently pricing in a 90% chance of a rate cut and that feels about right. There’s the possibility of a surprise, but a small one.”
While a rate cut is widely expected, recent wage growth figures have complicated the picture. Khalaf noted: “The latest wage growth reading was a hot one, which will give the Bank some pause for thought before they cut rates. A boost to the National Living Wage from April will add further fuel to the fire and will limit the ability of some companies to pass on the rise in National Insurance to employees through their wage packets. This will force businesses to take a hit to profits, or push through price rises to customers. The Bank will be especially sensitive to the latter given its potential to revive domestic inflation.”
Forecasts for rate cuts vary significantly, with estimates ranging from two to five reductions this year. Khalaf pointed to policy changes and global uncertainty as key factors in the Bank’s decision-making process: “There is a significant divergence of views on how many rate cuts we’re going to get from the Bank of England this year. Morgan Stanley reckons five, Goldman Sachs reckons four, and the market is pricing in two to three. This perhaps speaks to a volatile economic environment, with a new Labour government laying out a raft of policies designed to boost growth, while UK companies are yet to fully adjust to the policies announced in the Budget.”
Bond markets have been volatile, but gilt yields have returned to their levels at the start of the year. “An interest rate cut at the forthcoming meeting is unlikely to precipitate a major shift in gilt yields seeing as it is largely priced in, but the precise voting split and the accompanying commentary could spark some movement,” Khalaf said.
The Bank’s Monetary Policy Report, due alongside the rate decision, will provide further insight into economic forecasts and potential rate movements. Khalaf added: “The report will also deliver the Bank’s latest assessment of UK growth prospects. Its last detailed missive in November was a tick in the box for Rachel Reeves as it upgraded short-term growth estimates, citing the Budget as a contributing factor. The chancellor will be hoping the Bank doesn’t pour cold water on her current efforts to relaunch her growth agenda with some downbeat economic forecasts.”
