Split Bank of England will struggle to give clear outlook on interest rates, say economists

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The Bank of England is expected to cut interest rates when it meets this week — but splits on the Monetary Policy Committee and uncertainty over fiscal policy will prevent it giving clear steers on the longer-term outlook, economists say. 

Investors are betting on a near-certainty of the BoE cutting its benchmark rate by 0.25 percentage points to 4 per cent on Thursday, in the fifth such move since it began lowering borrowing costs two years ago. 

Market pricing points to two further cuts, taking interest rates to 3.5 per cent by the summer of next year.

But the vote is likely to be split, with the MPC repeating its mantra that it is taking a “gradual and careful” approach to cutting rates, and keeping its options open for future decisions. 

The more dovish MPC members — including externals Alan Taylor and Swati Dhingra — could favour a bigger cut based on worries about mounting job losses. They will be able to point to new evidence that the wage pressures underpinning persistent inflation are finally easing. 

A more hawkish group, including the BoE’s chief economist Huw Pill, is likely to focus on the continued overshoot in inflation, which rose to 3.6 per cent last month and is set to climb further before it subsides. 

This spike is mostly due to temporary factors, but the BoE fears households have become more sensitive to bursts of inflation, especially when driven by staples such as food, and will push for bigger pay rises in the expectation that higher inflation is now the norm.

“Doves will focus on rising downside risks from jobs, but hawks will see a persistent inflation problem. Both have a point,” said Robert Wood, chief UK economist at the consultancy Pantheon Macroeconomics. 

A group of “swing” voters, including BoE governor Andrew Bailey and three deputy governors, have not pushed back against market expectations of a cut this month. But nor have they given a clear steer on the pace at which rates could come down further ahead, or the level at which they could settle. 

Members in this group were likely to remain “non-committal”, said Jack Meaning, UK chief economist at Barclays, because of “the lack of a smoking gun definitively validating” the fears of either side.

Divisions on the MPC have become more entrenched since it last published economic forecasts in May, because the data remains so ambiguous. 

“The UK’s unfortunate ‘stagflation’ situation has not improved since the BoE’s last forecast round,” said Elizabeth Martins, senior economist at HSBC. Although uncertainty around tariffs had receded, the latest evidence still suggested underlying growth in GDP was “close to zero”, she said.

Employment and wage growth looked weaker, but inflation was more persistent, so the question would be, “which of these components is the MPC more worried about — the ‘stag’ or the ‘flation’,” she asked.

One new source of uncertainty is fiscal policy, given the growing likelihood that chancellor Rachel Reeves will need to announce fresh tax rises in the autumn to meet her fiscal targets. 

The BoE cannot factor in policy changes before they are announced and will not want to speculate. But Sandra Horsfield, economist at Investec, said it was “hard to imagine” that MPC members would ignore the possibility of fiscal tightening. 

Higher taxes would usually be seen as disinflationary but Thomas Pugh, economist at the audit firm RMS UK, said that “stealth” increases in sin taxes and duties could drive a repeat of last April’s step-up in inflation. 

Even with these uncertainties, the BoE could give a clearer steer on its thinking in one area — the decision it will take in September on the pace of quantitative tightening, or QT. The central bank’s bond-selling programme is increasingly seen by investors as a source of upward pressure on borrowing costs. 

The BoE has been running down its stock of bonds by £100bn to £560bn this year, but would need to step up active sales significantly to maintain this pace in the year from October.

Analysts believe it could signal that it is preparing to slow the pace of QT, or to shift the mix of sales towards shorter-dated bonds.