The Bank of England’s nine key decision-makers are set to cut their key interest rate again on Thursday by a quarter point to 4.5 percent, but not without a fair amount of heartache and soul-searching, analysts say.
The United Kingdom’s economy does not present a pretty picture right now: Both growth and unemployment are worse than what the Bank had projected the last time it published economic forecasts in November. And while inflation has been in line or below projections, a weaker pound and a pickup in wage growth risk keeping it alive for another year.
“It’s definitely a tricky period for the Monetary Policy Committee,” said Jack Meaning, U.K. chief economist for Barclays.
The Bank still believes it has broken the back of inflation and expects the medium-term weakness of the economy to bear that out. But with last year’s big drops in energy prices falling out of the annual calculations, headline inflation is set to remain clearly above its 2 percent target this year. After having fallen to a three-year low in September, it had already rebounded to 2.5 percent by the end of last year.
That, said the Barclays economist, creates something of a dilemma for the MPC, which has to balance the risks of an undershoot over the longer period against the risk that inflation expectations become unmoored in the immediate future, sowing the seeds of a new price cycle.
After surprisingly strong growth in the first half of the year, U.K. gross domestic product didn’t grow at all in the three-month period from September to November, as households and businesses reacted negatively to a first budget from the new Labour government which raised taxes without really making a dent in the deficit.
Analysts at Barclays expect the Bank to slash its 2025 growth forecast by 0.5 percentage points, to 1 percent, reflecting the loss of momentum over the turn of the year.
All of that speaks to more interest cuts in the short-term: Alan Taylor, the MPC’s newest appointee and seen by many as an intellectual heavyweight, said in a speech last month that the balance of risks had clearly shifted and that Bank may need time to cut as many as six times this year to support the economy. Analysts at Berenberg wrote that that could mean back-to-back cuts at the February and March meetings, breaking with recent practice that has seen the Bank act only when it updates its quarterly forecasts.
But at the same time, wages — a key element of service sector inflation that has been uncomfortably high for three years — most recently accelerated again: Private-sector average weekly earnings, excluding bonuses, rose at an annual rate of 6 percent in the three months through November. And Berenberg’s analysts pointed to signs in recent business surveys that the gentle trend downward in prices is also bottoming out.
“Over the course of this year, the debate will likely turn to whether this increase in prices will be (another) one-off or risks dislodging the low-inflation psychology that helped the BoE keep inflation close to 2 [percent] in the past,” they wrote.
One piece of relatively good news is that the U.K. is perhaps more insulated from the threat of United States tariffs compared to its European peers, not least because of the high proportion of services in its exports. These have typically been less politically inflammatory than goods. Overall, according to its own data, the U.S. runs a trade surplus with the U.K., in contrast to its massive deficit with the European Union.
“The U.K. is out of line but … I think that one can be worked out,” President Donald Trump said at the weekend. By contrast, he referred to the EU an “atrocity.”
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