The Bank of England (BoE) is set to hold its first policy meeting of the year on February 6, and markets are already pricing in a 25-basis-point rate cut. In its last meeting in December, the BoE’s Monetary Policy Committee (MPC) voted 6-3 to keep interest rates at 4.75%, with three members supporting a 25-basis-point cut to 4.5%. However, with inflation cooling and economic signals weakening, expectations for a rate cut have risen significantly.
Recent economic data has reinforced these expectations. UK inflation, which had risen from 1.7% in September to 2.6% in November, slightly eased to 2.5% in December. More importantly, core inflation dropped to 3.2%, its lowest level since September. At the same time, the job market is showing signs of weakening, with the unemployment rate rising to 4.4% in November, its highest level since May. Additionally, the UK’s GDP growth for November was just 0.1%, below market expectations of 0.2%.
With these factors in mind, the market sees a 90% probability of a 25-basis-point rate cut this week. If confirmed, it would mark the BoE’s third rate cut since it began its easing cycle in August 2024. Markets are also pricing in a total of 70 basis points in rate cuts for 2025, signaling expectations for further monetary easing.
Even before the BoE’s decision, major banks have already begun lowering mortgage rates. Barclays and Coventry Building Society have reduced rates on home loans, particularly for energy-efficient properties. The Sonia swap market, which replaced Libor, is also reflecting expectations of lower rates, with 5-year swap rates declining from 4.12% to 3.92% over the past three weeks.
However, inflation remains a key concern. The BoE’s December forecast projected that CPI inflation could rise to 3% in the second quarter of 2025, higher than the previous estimate of 2.6%. Wage growth has also been stronger than expected, with UK salaries rising 5.6% year-over-year between September and November. This has raised concerns that businesses may pass on higher costs to consumers, keeping inflation elevated.
Political pressure is another factor at play. UK Chancellor Rachel Reeves has introduced tax policies that may further increase labor costs, and some members of the MPC are expected to resist immediate rate cuts. Additionally, global trade concerns, including tariffs imposed by the U.S., are complicating the inflation outlook.
The British pound has also been under pressure, particularly against the U.S. dollar, due to expectations of higher U.S. interest rates. A weaker pound raises the cost of imports, which could add to inflationary pressures.
Despite these uncertainties, the International Monetary Fund (IMF) has a more optimistic view, predicting that UK wage growth and inflation will slow, allowing for up to four BoE rate cuts this year. Investors will be closely watching the BoE’s decision and its forward guidance on interest rates to gauge the future direction of UK monetary policy.
