Bank of England Holds Interest Rates but Signals More Cuts Ahead

A Divided Decision with Implications for the Future

The Bank of England has decided to keep interest rates steady at 3.75%, but the decision was far from unanimous and comes with a clear message: further rate cuts are on the horizon. In what turned out to be one of the closest votes in recent memory, five members of the nine-person Monetary Policy Committee (MPC) voted to maintain the current rate, while four members pushed for an immediate reduction to 3.5%. Governor Andrew Bailey found himself in the pivotal position, casting the deciding vote to hold rates where they are. This razor-thin margin and the increasingly optimistic language from the Bank suggest that we won’t have to wait long for the next cut—possibly as soon as the committee’s next meetings scheduled for mid-March or early April. Financial markets, which had been anticipating two rate cuts this year even before this announcement, are now watching closely to see how quickly the Bank will move. Governor Bailey’s comments were reassuring for households and businesses alike, as he indicated that inflation is finally returning to more manageable levels and that further reductions in borrowing costs should be possible if current trends continue.

Inflation Returning to Target Faster Than Expected

The decision to hold rates, rather than cut them immediately, reflects the Bank’s latest economic forecasts, which paint a surprisingly positive picture when it comes to inflation. The Bank now expects inflation to fall back to its 2% target by the second quarter of this year—sometime in the spring—which represents a significantly faster decline than previously anticipated. This is particularly encouraging when you consider that inflation stood at 3.4% as recently as December. Governor Bailey emphasized this progress, stating, “We now think that inflation will fall back to around 2% by the spring. That’s good news.” However, he also stressed the importance of ensuring that inflation doesn’t just hit the target briefly but stays there sustainably, which is why the committee chose caution this time around. The Bank’s analysis identified several factors contributing to this more rapid decline in inflation, including government interventions on energy costs and a slowdown in food price increases. These developments have created a more favorable environment than economists had forecast just a few months ago, giving policymakers confidence that the worst of the inflation crisis may finally be behind us.

Government Measures Providing Inflation Relief

A significant portion of the expected inflation decline can be attributed to specific measures announced by Chancellor Rachel Reeves in last November’s budget. The Bank’s forecasters calculated that changes to how energy bills are calculated will shave approximately 0.5 percentage points off the inflation rate—a substantial impact that will be felt by households across the country. These changes are expected to save the average household around £150 annually on their energy bills, providing welcome relief after years of elevated costs. Beyond energy, the Chancellor also announced a freeze on rail fares and fuel duty, both of which help to reduce pressure on household budgets and contribute to the overall moderation in price increases. Additionally, food price inflation, which had been a major driver of overall inflation in recent years, has been coming down more rapidly than expected, further supporting the case for lower overall inflation. These combined factors have created a situation where the Bank can be more confident about inflation returning to target without needing to keep interest rates at restrictive levels for as long as previously thought. However, the Bank’s forecast also contained some less optimistic news for the broader economy, with GDP growth predictions being revised downward from 1.1% to just 0.9% for this year, and unemployment expected to rise to 5.3%, suggesting that while inflation is improving, economic growth remains sluggish.

Balancing Multiple Economic Risks

The decision to hold rates at 3.75% rather than cutting them immediately reflects the delicate balancing act that the Monetary Policy Committee must perform. On one hand, there’s the risk of persistent underlying inflation, particularly driven by wage growth, which could cause prices to start rising again if rates are cut too quickly or too aggressively. On the other hand, there’s the danger that increasing unemployment and weak consumer spending could actually push inflation below the 2% target, creating a different set of economic problems. The committee acknowledged this complex situation in its statement, noting that “the risk from greater inflation persistence has continued to become less pronounced, while some risks to inflation from weaker demand and a loosening market remain.” This careful language indicates that while the committee is becoming more confident about inflation, they’re also aware that the economic environment remains fragile. The rising unemployment forecast and subdued GDP growth projections suggest that the economy isn’t exactly firing on all cylinders, which could create downward pressure on prices if the Bank isn’t careful. This is why, despite the good news on inflation, a majority of the committee felt it was prudent to wait a bit longer before implementing another rate cut, ensuring they have a clearer picture of whether the inflation decline is truly sustainable.

Questions About Long-Term Sustainability

While the short-term inflation outlook has improved significantly, some members of the Monetary Policy Committee remain skeptical about whether this improvement will last. The concern centers on whether the temporary measures announced by the government—such as the energy bill changes and fare freezes—will be enough to offset underlying inflationary pressures in the economy. Wages, in particular, continue to grow at rates that some committee members view as inconsistent with sustained 2% inflation over the medium term. The timing of any further rate cuts will depend heavily on the Bank’s assessment of how sustainable the 2% inflation rate will be once these temporary government measures work their way through the system. If wages continue to rise rapidly and businesses pass these costs on to consumers through higher prices, inflation could tick back up again, forcing the Bank to reconsider its easing path. This uncertainty explains why some committee members wanted to see more evidence before committing to further cuts, even as inflation approaches the target level. The Bank will be watching wage data, services inflation, and business pricing behavior very closely in the coming months to determine whether the improvement in headline inflation reflects a genuine easing of underlying price pressures or is merely a temporary phenomenon driven by specific government interventions and energy price movements.

Governor Bailey’s Pivotal Vote and What It Means for Borrowers

Perhaps the most intriguing aspect of this decision was Governor Andrew Bailey’s switch from his previous position. In the December meeting, Bailey had voted with the more dovish members of the committee who favored cutting rates, but this time he joined the majority in voting to hold. This flip wasn’t necessarily a sign that Bailey has become more hawkish on inflation, but rather an indication that he wants to see a bit more evidence before committing to further easing. His decisive vote kept the committee from being deadlocked and prevented an immediate cut, but his language strongly suggests that he’s ready to support cuts in the near future if the data continues to improve. The four members who voted for an immediate cut—Sarah Breedon, Swati Dinghra, deputy-governor Dave Ramsden, and Alan Taylor—represent the more dovish wing of the committee that’s more concerned about weak economic growth and rising unemployment than about residual inflation risks. Meanwhile, those voting to hold—Megan Greene, Clare Lombardelli, Catherine Mann, and Huw Pill, along with Bailey—appear to want just a bit more confirmation that inflation is truly under control before easing policy further. For people with mortgages, credit cards, and other loans, this decision means that relief from high borrowing costs is coming, but perhaps not quite as quickly as some had hoped. The message from the Bank is clear: barring any unexpected developments, interest rates will come down further this year, potentially making borrowing cheaper and saving more attractive as the year progresses. The key phrase from Governor Bailey—”all going well, there should be scope for some further reduction in the Bank rate this year”—provides the clearest signal yet that the direction of travel is downward, even if the exact timing remains flexible depending on how the economic data unfolds in the coming weeks and months.