Bank of England holds interest rates amid calls for faster cuts

Bank of England Governor Andrew Bailey (Bloomberg image)

• Bank of England keeps rates at 3.75% in close 5-4 vote, signaling dovish stance
• Inflation to drop below 2% in 2027; growth and jobs to weaken.
• Governor Bailey hints at possible rate cuts later this year if conditions allow

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The Bank of England came within a vote of cutting interest rates as policymakers split 5-4 in favor of holding at 3.75%, after its updated forecasts showed inflation falling below target, growth slowing and unemployment rising.

Governor Andrew Bailey was once again the swing voter, choosing to leave rates unchanged this month having cut at the last meeting in December. He said in the personal statement explaining his decision that “my central outlook is aligned with the staff’s view of weaker demand.”

In a separate statement, Bailey said: “All going well, there should be scope for some further reduction in bank rate this year.”

The pound extended earlier losses against the dollar, falling as much as 0.8% to $1.3552. Gilts rallied, led by shorter-dated tenors, with two-year yields falling seven basis points to 3.65%.

The Monetary Policy Committee’s decision was far more dovish than anticipated, with the close call not reflected in market pricing before the meeting for a near-zero chance of a reduction. Earlier Thursday, the pound dipped and gilt yields rose as speculation mounted over the future of Prime Minister Keir Starmer.

The bank’s forecasts showed inflation returning to the 2% target in April and then falling below for much of 2027. The minutes of the MPC’s meeting said there was “evidence of subdued economic growth and building slack in the labor market.” The upside risks to inflation have “become less pronounced,” it added.

Both Bailey and Catherine Mann — an external MPC member also among the five to hold this month — signalled that they are close to moving into the rate-cutting camp. They “placed greater emphasis on the risks to inflation from weaker activity,” the minutes said.

The BOE has been trying to strike a balance between sticky inflation, which has proved more difficult to tame than in most major advanced economies, and signs of a weakening jobs market. British firms are cutting back on hiring and redundancies are on the rise.

Inflation is still well above target at 3.4% but the BOE’s forecasts showed a consistent easing of pressures. From April until the start of 2029, inflation does not rise above 2% again and spends four quarters below target, according to the projections.

The overall projections are based on interest rates bottoming out at 3.25% by the end of this year then climbing back to around 3.75% in 2029.

All four of the MPC’s doves - Swati Dhingra, Alan Taylor, Dave Ramsden and Sarah Breeden - voted for a cut, defying the expectations of most economists who had thought only two or three would push for more easing.

The Labour government’s November budget removed social and climate levies from household energy bills and made cuts to other regulated prices; the BOE said this will mechanically lower inflation in the second quarter by 0.5 percentage points.

Alongside the decision, the BOE released its latest economic forecasts. Growth this year has been downgraded sharply to 0.9% from 1.2% and to 1.5% from 1.6% in 2027. In 2028 the economy is forecast to grow 1.9%, marginally faster than the previous 1.8% projected.

Weaker growth is accompanied by a worse outlook for unemployment. Joblessness now peaks at 5.3% in the second quarter of this year, up from the latest official reading of 5.1%. Across 2026, unemployment is around 0.3 percentage points higher than previously thought - implying about 100,000 more people out of work.

The bank anticipates weaker bargaining power among employees will help keep annual pay rises to 3.25% this year, a level the bank says is consistent with 2% inflation. It was more optimistic on productivity but has not changed its estimate of potential long-term output growth of around 1.4%.

Earlier this week, Australia reversed course after a brief easing cycle last year and raised interest rates on concerns about an overheating labor market, underlining the delicate task ahead for policymakers across the world.