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Economists are divided on the future of interest rates following the Bank of England’s recent decision to reduce the Bank Rate for the first time since 2020. Governor Andrew Bailey emphasized the need for caution, warning that interest rates should not be cut too quickly or by too much. However, investors are speculating on more cuts, with markets nearly pricing in two 25 basis point reductions this year, up from one before the meeting, and a further four cuts next year.
The trajectory of interest rates largely hinges on the inflationary outlook, which remains a contentious issue within the Bank’s Monetary Policy Committee (MPC). The latest vote revealed a split, with five members supporting a rate cut and four advocating for a hold.
According to the central scenario outlined in the Monetary Policy Report (MPR), inflation is expected to rise to 2.7% by the end of the year before gradually returning to target levels. However, Bailey presented an alternative scenario during a press conference, suggesting that the economy might have undergone a “more permanent change to wage and price setting,” which could necessitate a more aggressive policy response. This perspective is supported by a minority within the MPC, including Chief Economist Huw Pill.
Pill voiced concerns about persistent dynamics in the UK economy, hinting at the need for caution in future rate cuts. Despite this, some economists remain unconvinced by the Bank’s cautious approach. Ruth Gregory, Deputy Chief UK Economist at Capital Economics, predicted two more rate cuts this year, arguing that domestic inflationary pressures might be weaker than the Bank anticipates.
Dutch bank ING also expects at least one more rate cut this year, citing potential improvements in data on services inflation and wage growth. ING economist James Smith suggested that these factors could make the committee more comfortable with further reductions.
Conversely, Rob Wood, Chief UK Economist at Pantheon Macroeconomics, warned that markets might be overestimating the number of cuts. He forecasted only one more cut this year and three next year, pointing to recent job market data as evidence that the MPC might hold off on further cuts.
Analysts at Royal Bank of Canada echoed this sentiment, predicting just one more cut this year, citing underlying inflation indicators as a potential constraint on the MPC’s ability to deliver more reductions.
