MPC preview: interest rates on hold until April
We expect a 6-3 vote split at ThursdayҴýs Monetary Policy Committee (MPC) meeting, but this time the majority will likely lean towards a hold rather than another cut, leaving rates at 3.75%. Growth picked up in November and surveys also suggest a strong start to the year, whichҴýll probably be enough for the MPC to hold, despite a continued loosening in the labour market. We also expect the guidance to continue to indicate that more cuts are likely, but that the MPC will be increasingly cautious on the timing and number of additional rate cuts needed as they approach neutral.
Looking beyond next Thursday, we expect just one cut this year and for that to be in April. However, if the labour market continues to weaken and that translates into a faster-than-expected slowdown in pay growth, then the MPC could be convinced to cut further.
Recent UK economic data supports an MPC hold
After cutting in December, we expect the MPC to vote 6-3 in favour of a hold next week. We think Bank of England (BoE) Governor Andrew Bailey and Deputy Governor Sarah Breeden, who previously voted to cut, will join the hawks in voting for a hold this time around. The vote may be closer at 5-4, which would call on Governor BaileyҴýs casting vote.
The latest data supports the case for a hold. The UK economy managed to bounce back in November, growing by 0.3%, and is on track to beat the MPCҴýs latest forecast of 0% growth in Q4. WhatҴýs more, the survey data suggest this momentum continued into December and January, shoring up our view that the economy will grow 0.5% in Q1.
Admittedly, inflation undershot the MPCҴýs forecast in December by 0.1ppt. The rise in food inflation, which plays an outsized role in setting householdsҴý inflation expectations, was the biggest surprise.
Inflation will fall back to only a little above 2% in April as the ChancellorҴýs Budget measures come into effect. Indeed, this will be the first time the MPC factors NovemberҴýs Budget announcements into its forecasts. The energy bill cuts, rail-fare freezes and the delay to the hike in fuel duty should knock about 0.5ppts off inflation in Q2 and Q3. However, underlying measures of inflation will be stickier and the MPC will want to look through these one-off reductions in headline inflation until it can be more certain that lower headline inflation is feeding through into lower inflation expectations. ThatҴýs especially because Budget policies will, in theory at least, raise inflation in 2027 and 2028, which matters more to the MPCҴýs rate-setting timeframe. However, if the planned fuel duty increases were delayed again, that rise in inflation may not materialise.
Wage growth also remains too strong for inflation to stabilise at 2%. Vacancies have been gradually trending up since the summer, which should help the labour market to stabilise in the coming months.
As a result, we think a hold next week is a sure bet, as do financial markets, which are pricing in just a 1% chance of a cut. Steady, if unspectacular, growth should be enough to convince the MPC to stay on the sidelines until inflation drops back below 3%.
FebruaryҴýs meeting also brings a review of the BoEҴýs supply-side estimate: thatҴýs how quickly the UK economy can grow without impacting inflation. We doubt the BoE will make any revisions to its productivity estimate, which is around 0.8% per year, but sharply slowing net migration will likely lower its estimate of labour supply growth.
One cut and done for BoE in 2026?
Beyond next weekҴýs meeting, there are a couple of reasons why we think thereҴýs limited scope for further rate cuts this year.
First, our best estimate of neutral Ҵý where interest rates are neither restrictive nor accommodative Ҵý is 3.5%. The MPC will have to be even more cautious about further cuts as it gets closer to this level. This concept is clearly climbing up the MPCҴýs agenda. ҴýNeutralҴý was mentioned seven times in , up from four in November and zero in September. Edging closer to neutral will create a higher bar to further rate cuts. ItҴýs the main reason why we think the MPC will cut just once, in April, this year.
Second, forward indicators suggest pay growth will stabilise at around 3.5%. Megan Greene, one of the more hawkish MPC members, recently stated that her biggest concern was sticky pay growth and that Ҵýsuch wage growth is not target-consistentҴý. WhatҴýs more, the BoEҴýs own measure of underlying services inflation − a proxy for domestic inflationary pressure that strips out the impact of regulated prices − has been stuck at 4% since the summer with little sign of further disinflation as our chart below shows.
However, itҴýs not hard to imagine a scenario where the weakness in the labour market persists − instead of easing as in our forecast − or growth disappoints as consumers decide to keep saving, rather than spend. In those scenarios, the BoE would need to cut rates further to support the economy. In any case, our base case is for steady growth and the labour market to gradually recover across the year, limiting the BoEҴýs ability to cut beyond 3.5%.
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