The Bank of England has reduced interest rates, only the second such cut since 2020. Signalling cautious optimism, it hinted that further cuts might come, though likely with a slow hand. This reduction followed closely on the heels of the government’s latest budget, which has stirred expectations of both elevated inflation and modest growth in the near term.

In an 8-1 vote, the Monetary Policy Committee (MPC) opted to bring rates down from 5% to 4.75%, with a wider consensus than anticipated; a Reuters poll had forecasted a 7-2 split. The lone dissenter, Catherine Mann, argued to keep the rates steady.

BoE Governor Andrew Bailey underscored the delicate balancing act required: "We need to make sure inflation stays close to target, so we can't cut interest rates too quickly or by too much," he asserted. Yet, Bailey also indicated a gradual path forward for further cuts, provided the economic landscape aligns with the Bank’s projections, mirroring his cautious remarks from September.

Chancellor Rachel Reeves’ recent budget, a substantial fiscal package encompassing tax hikes, increased public spending, and expanded borrowing, is projected to lift the UK’s economic output by an estimated 0.75% next year. However, any longer-term growth benefits appear constrained; the Bank anticipates minimal impact on annual growth rates over the subsequent two to three years.

On the inflation front, the BoE expects Reeves’ policy measures to add roughly 0.5% to inflation at its apex, pushing the timeline for hitting the 2% target back by another year. The Bank’s tone on potential rate cuts remains circumspect, consistent with its past approach, contrasting the European Central Bank’s pace, which many investors view as comparatively swift.

Interestingly, the BoE made no mention of Donald Trump’s election victory in the United States, despite its impact on global rate expectations. Trump's win has dampened speculation that the Federal Reserve might pursue aggressive rate cuts, yet the Bank of England’s focus remains inwardly directed, attentive to UK-specific fiscal dynamics.

The financial markets have adjusted accordingly; where previously up to four rate cuts were anticipated by 2025, expectations have tempered to two or three cuts in light of the new fiscal outlook. In line with these recalibrations, the BoE forecasts inflation to rise from 1.7% in September to around 2.5% by year’s end, peaking at approximately 2.7% next year, and then gradually descending below the 2% target by the end of the three-year forecast horizon.

Key government policies—like raising the bus fare cap, increasing VAT on private school fees, and hiking employers' social security contributions—are expected to exert upward pressure on inflation. Combined with a sharp 6.7% rise in the national minimum wage, these measures heighten costs for employers, who may face tough choices between absorbing these expenses, reducing workforce numbers, or accepting smaller profits. The BoE acknowledged the uncertainty surrounding the full inflationary impact, as employer responses to these pressures remain unpredictable.

Reflecting slight adjustments in recent economic data, the BoE revised its growth forecast for 2023 down from 1.25% to 1%, though it raised the outlook for 2025 to 1.5%. “This reflects the stronger, and relatively front-loaded, paths for government consumption and investment more than offsetting the impact on growth of higher taxes,” the BoE noted.

The Bank’s forecast, however, does not account for the significant surge in market borrowing costs that emerged following the budget release, as its assumptions were set beforehand. Factoring in these heightened rates would likely trim both inflation and growth projections.

Reaffirming its cautious stance, the BoE reiterated that monetary policy would need to remain “restrictive for sufficiently long” to bring inflation sustainably back to its 2% target.