(Bloomberg) -- The Bank of England cut borrowing costs for the second time this year, but stopped short of signaling faster easing, warning that last week’s budget could drive up inflation by as much as half a percentage point.
The Monetary Policy Committee led by Governor Andrew Bailey voted 8-1 to lower the benchmark interest rate by a quarter point to 4.75%, with Catherine Mann, an external official, the sole dissenter. The outcome was widely anticipated by economists.
“We need to make sure inflation stays close to target, so we can’t cut interest rates too quickly or by too much,” Bailey said in a statement on Thursday in London. “But if the economy evolves as we expect, it’s likely that interest rates will continue to fall gradually from here.”
The pound edged up after the decision while two-year UK bonds gained. Traders are fully pricing two more quarter-point reductions by the end of next year, with just under a 50% chance of another.
The BOE’s path to further easing has been complicated both by Chancellor of the Exchequer Rachel Reeves’ Oct. 30 budget and the election of Donald Trump as US president. The UK now plans a £70 billion ($90.4 billion) a year spending binge, almost half of which is financed by borrowing. Trump is threatening higher tariffs in a new global trade war.
“The MPC is now dealing with two new inflation shocks: Mr Trump and the budget,” Rob Wood, chief UK economist at Pantheon Macroeconomics and a former BOE official, said in a report. The result “means more hawkish interest-rate policy.”
Earlier Thursday, J Sainsbury Plc, Britain’s second-largest grocer, warned that higher payroll taxes and wage increases planned by the Labour government could bring inflation back to UK supermarket shelves.
Bond markets took fright in the budget’s aftermath, with UK government borrowing costs hitting one-year highs. That stirred memories of the financial meltdown triggered in 2022 when then-Prime Minister Liz Truss’ £45 billion of unfunded tax cuts rattled investors — though BOE Deputy Governor Dave Ramsden insisted to reporters that last week’s repricing was “orderly.”
The recent large market moves meant that the BOE based its forecasts on a lower path for borrowing costs than traders envisaged. Using an implied outlook for rates to fall to 3.7% by the end of next year and remain there, officials see inflation above the 2% target, at 2.2% after two years. It then slows below the goal to 1.8% in the course of 2027.
What Bloomberg Economics Says...
“Looking ahead, we continue to think the Monetary Policy Committee will keep rates steady at its next meeting and ease at a quarterly pace in 2025.”
—Ana Andrade and Dan Hanson. For their BOE REACT, click here
While markets saw rates remaining almost half a percentage point higher, implying a sharper slowdown in consumer price growth, officials stuck with guidance that “based on the evolving evidence, a gradual approach to removing policy restraint remained appropriate.”
The tone of the BOE decision convinced traders that this was the last rate cut of the year. Money markets now imply around a 15% chance of another quarter-point reduction in December, from 25% before the decision and about 70% at the start of last month.
Investors are also forecasting less easing next year, with markets fully pricing two cuts with a third hanging in the balance. The repricing boosted the pound, with sterling up 0.9% to $1.2992.
The BOE reduction precedes a step of the same size seen likely from the Federal Reserve later on Thursday, in the first US decision since Trump’s victory.
In the quarterly Monetary Policy Report accompanying the UK cut, policymakers estimated that Reeves’ budget will drive up inflation by half a point compared with its August forecast, peaking at 2.8% in the third quarter of 2025.
Consumer price growth is currently below the 2% target at 1.7%, but the forecasts show higher energy prices lifting it to 2.5% by December. The budget stimulus also lifts the level of UK gross domestic product by 0.75% at its peak impact next year.
Policymakers voted on Wednesday shortly after the US election results became clear, but the minutes of their meeting hardly mentioned the risks of a trade war. Bailey, questioned by reporters on the matter, insisted that “we’re not going to respond to anything” to do with prospective US policies.
Asked whether US tariffs or the UK budget are a bigger problem for the BOE, Bailey stressed the impact of global events, based on the first half of his term as governor.
“The external shocks have been the big ones,” he said. “Don’t get me wrong, we’re going to watch the impact of the UK budget very carefully.”
While the chancellor herself described the rate cut as “welcome news” for homeowners and businesses, emphasizing that borrowing costs are on a downward path, BOE officials are indeed more guarded about the impact of her budget.
The central bank sees impacts on wages, profit margins and jobs from measures it includes to raise wages for lower-paid workers and impose higher payroll taxes on employers.
BOE officials will watch for such effects playing out. The central bank added that some of the recent steep fall in services inflation was “expected to unwind.” The labor market “continues to loosen, though it appears relatively tight by historical standards,” it added.
--With assistance from Constantine Courcoulas, Irina Anghel, Tom Rees and Aline Oyamada.
(Updates with markets starting in fourth paragraph)
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