The Bank of England will almost certainly leave interest rates on hold on Thursday and wait for more evidence that inflation is under control, despite mounting concerns about the UK labor market.
Markets put the chance of a quarter point rate cut at less than 1% and only one of 32 economists surveyed expects a reduction. The rest believe rates will remain unchanged at 3.75%, a three year low, with the majority anticipating a 7-2 vote split. External members of the Monetary Policy Committee Alan Taylor and Swati Dhingra are expected to be the doves. The decision will be announced at 12 p.m. in London.
At the last meeting in December, Governor Andrew Bailey swung the vote 5-4 for a quarter point cut but the MPC said reductions from now on would “become a closer call,” in updated guidance. Several UK economists expect the next cut to be in April. Markets put the chance of an April reduction at 70% and for policy to then stay unchanged.
All nine MPC members agree that monetary policy is restrictive, and bearing down on inflation, but to varying degrees. Inflation is still elevated at 3.4%, raising concern among the hawks, but it is forecast to fall to the 2% target in the second quarter of the year. Others are more worried about the labor market. Unemployment has risen to 5.1%, above than the BOE's November forecast for 5% in the final quarter of 2025.
Vote Split
Bailey swung a close decision in December, with the committee 5-4 in favor of easing policy. This time he is expected to vote with the majority to hold but has signalled more cuts are coming and may do so again.
“There's good reason to expect a bit more of a downward path,” he told the BBC on Dec. 19, the day after the last meeting. Most economists expect a 7-2 split, with the two perma-doves Dhingra and Taylor preferring another quarter point cut.
Since the December meeting the data has been slightly contradictory. Monthly GDP in November was 0.3%, far better than expected. Private sector activity grew at the fastest pace in two years, according to January's S&P Global purchasing managers' index, and Christmas retail sales were also positive.
Against that, joblessness has risen and redundancies have accelerated.
Guidance
The MPC changed its guidance in December to deliver what was widely seen as a hawkish cut. While rates are “likely to continue on a gradual downward path,” the committee said, “judgments around further policy easing will become a closer call.”
The bank is not expected to revise this new guidance, which reflects the fact that policy is now close to neutral so the committee needs to move more carefully. Hawkish members, such as external member Megan Greene and chief economist Huw Pill, remain concerned about high inflation expectations. On the flip side, Dhingra and Taylor are swayed by weakness in the labor market.
New Forecasts
The BOE publishes its Monetary Policy Report alongside the decision on Thursday. It will include new economic forecasts and, probably, a fuller assessment of the impact of the Labour government's November budget.
Inflation this year will be materially lower than forecast, as Labour's removal of social and climate levies from household bills and freezing of rail fares will mechanically reduce inflation by half a percentage point, the December MPC minutes said.
Bloomberg Economics expects its inflation outlook to be marginally higher in the medium term. Its short term unemployment forecast may also be higher. The growth forecasts are likely to be largely unchanged.
Photo Credit: Bloomberg
Wages
One of the more important accompanying releases will be the report of the bank's agents, who gather information from businesses across the country. Alongside the agents report, the BOE will publish its Decision Maker Panel. Both will include analysis of the projected pay rises businesses will make this year, which could have implications for inflation. If they are above 3.5% that would not be in keeping with a 2% inflation target, which may give the MPC more reason to pause before cutting further, Oxford Economics said.
Photo Credit: Bloomberg
Supply Stocktake
The BOE will also update its estimate of the economy's supply potential, the pace at which it can grow without generating inflation. Since last year, there has been evidence migration is falling. A smaller projected population may lead the bank to lower its estimate of potential growth unless it upgrades productivity. Bailey has spoken about the productivity boost recent developments in artificial intelligence can deliver, but the BOE may decide it is too early to make that judgment.
Another key judgment is the equilibrium unemployment rate, below which inflation takes hold as workers can bargain for higher pay. The bank's last MPR raised questions about the stable rate. If it concludes equilibrium unemployment has edged higher, that would imply fewer rate cuts.
Overall, the clearest measure of policy restrictiveness would be to compare the current interest rate with the bank's estimate of “neutral,” currently somewhere around 2-3%. However, the BOE has been reluctant to specify its estimate of neutral, and is unlikely to provide more detail on its thinking on Thursday.
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