Bank of England – Less dovish than meets the eye
The Bank of England lowered interest rates yesterday by 25bp, taking Bank Rate to 4.5%, as was widely expected. Much more surprising was the vote split, with a seeming about-turn from long-time hawk Catherine Mann, who joined long-time dove Swati Dhingra in voting for a 50bp cut (the vote was 7-2 in favour of 25bp). We expect the BoE to continue cutting at a quarterly pace for the time being, but for Bank Rate to settle at an elevated 3.5% in 2026.
Mann’s puzzling dissent for a 50bp cut
While not specifically attributed by name, the said of one of the 50bp dissenters: “a more activist approach at this meeting would give a clearer signal of financial conditions appropriate for the United Kingdom, even as monetary policy would need to remain restrictive for some time to anchor inflation expectations, and Bank Rate would likely stay high given structural persistence and macroeconomic volatility.” Given the hawkish tone of the latter part of this statement, this almost certainly refers to Catherine Mann. While a puzzling move, Mann appeared to want to counter the unwarranted tightening of financial conditions driven by the rise in US bond yields, which has also spilled over to UK gilt (and other European bond) yields. It is likely therefore that Mann remains on the hawkish end of the spectrum fundamentally, and financial markets – which responded initially by raising expectations for BoE cuts – arguably overreacted to the news.
BoE significantly raises inflation forecast, but seems unfazed by it
In its quarterly , the Bank raised its near-term inflation projections by c1pp, with CPI inflation now expected to peak at 3.7% in Q3 this year, up from 2.8% in its November projection. This is despite the conditioning assumptions of a higher Bank Rate vs November (at 4.2% in Q1 26 vs 3.7% in November). The MPR attributed the rise almost entirely to energy (such as the recent rise in natural gas and electricity prices) as well as other administrative changes, with the Bank judging that there would be much less second round effects from the near-term pickup in inflation due to the greater margin of spare capacity judged to be in the economy.
The BoE is also pinning its hopes on a sharp drop in wage growth
Wage growth remains very high in the UK, and far above levels consistent with the 2% inflation target, at c6% as of the most recent official readings, as well as the more timely Indeed tracker for new job vacancies. The MPR points to surveys that suggest wage growth will fall sharply in the course of the year, to nearer 4%. These surveys have ‘a good track record’, and this seems to be giving the MPC the confidence to forge ahead with rate cuts despite persistently high wage growth and high inflation expectations until now.
We remove our pause in rate cuts, but see a higher Bank Rate further out
With the MPC seeming to give high wage growth the benefit of the doubt, and given the tepid nature of the recovery, we see the MPC continuing to cut rates in the near-term, but at a gradual, 25bp-per-quarter pace (at the May, August and November meetings). Previously, we expected a pause at the May meeting. However, we think inflation will take longer than the MPC thinks to get back to the 2% target, and as such we see Bank Rate settling at a higher 3.5% level in 2026, compared with our previous expectation for a fall to 3.25%. This would leave Bank Rate just within the upper end of neutral rate estimates (these were updated in today’s MPR to between c2.25-3.9%). While we have removed our expectation for a near-term pause in rate cuts, we see a significant risk that the MPC has to pause or even abort rate cuts later this year, particularly if wage growth does not fall as sharply as survey indicators currently suggest.
What about the looming threat of tariffs?
As for other major economies, the threat of new US tariffs poses a significant risk to the outlook for the UK economy, although this is much less than more export-dependent economies. For perspective, goods exports to the US are around 2% of UK GDP, but 4.5% of German GDP. Moreover, president Trump has that the UK may get a carve-out from US tariffs. Were tariffs to be imposed, they would weigh on UK growth and inflation but by a smaller magnitude than for the eurozone. Given this, we would see tariffs as reducing the chance of an early end to BoE rate cuts, rather than spurring much more rate cuts. Naturally this would depend on the size of such tariffs – not just on the UK but also on its key trade partners.