BoE base rate: gradual and careful approach rules the day

As expected, the Bank of England (BoE) kept interest rates on hold at 4.5% and kept its guidance that a “gradual and careful” approach towards policy easing is correct. The most interesting part was the vote split. Just one member voted for a 25bps cut with eight voting to maintain rates. This should not diminish the chances of a May cut by much, but it clearly shows a hawkish tilt compared to the vote split last month. 

Uncertainty turns doves into hawks

The word uncertainty appeared 17 times in the March minutes compared to just eight in February. Everywhere the Monetary Policy Committee (MPC) looks, uncertainty has risen. US tariff policy has triggered doubt about the strength of the global economy and global inflation, which has heightened financial market volatility. 

On the domestic front, the dodgy employment data means the state of the labour market is uncertain. How firms will react to higher employment taxes is yet to be seen. 

What we do know is that inflation is heading back up towards 4% later this year, while growth remains subdued. Even with the BoE upgrading its growth forecast for Q1, it has still only pencilled in 0.25%. 

Normally in a weak growth environment the MPC would want to cut rates wherever possible. However, there are a few reasons why they must be cautious. 

Wage growth is 5.8%. This is roughly double the 3% compatible with 2% inflation. If consumers decide to stop saving and start spending, then that could prompt inflation to rise. 

The minutes also reveal that the MPC is clearly worried about inflation expectations. These have risen to between 3.4% and 4%. The minutes emphasised the need to “ensure longer-term expectations were anchored at 2%”. Unanchored expectations mean that one-off shocks, such as tariffs, prompt workers to negotiate pay rises to compensate for higher prices. 

Higher wages increase demand, triggering price rises. Rising prices then prompt further wage demands, increasing firms’ production costs, putting even more pressure on prices. That creates a spiral that, if not broken, could lead to runaway inflation. 

However, if expectations are anchored, then employees expect inflation to return to 2% in the medium-term. They do not negotiate for significant pay rises because of short-term shocks. That would allow the BoE to look through one-off price increases. Elevated expectations are therefore especially risky at a time where one-off shocks, such as increased Employer NICs or tariffs, are imminent.

Given the current uncertainty and trade-offs between low growth and rising inflation, continuing on a gradual and careful path seems sensible. Yet, the economy is clearly stagnating and the labour market treading water at best. As a result, the Bank will still want to cut interest rates where possible and find a less restrictive path to support growth while keeping inflation in check. 

Risks tilt towards fewer cuts 

The 8-1 vote split clearly constitutes a hawkish hold. One of the MPC’s more activist members, Catherine Mann, voted for a 50bps cut last month, yet voted to hold this time round. The dovish members of the MPC have even turned hawkish. Dave Ramsden and Alan Taylor had voted for a cut at every meeting since November. This time they voted to hold. Even the most dovish member, Swati Dhingra, only voted for a 25bps cut. As recently as January, Alan Taylor was arguing that “we could need a more accelerated pace of cuts, perhaps 125 or 150bps”. This scenario feels increasingly unlikely. 

While the MPC acknowledged that risks lie in both directions – with growth disappointing and a stagnant labour market – clearly Thursday’s meeting shows the BoE is putting far more weight on the hawkish risks as they hold to let measures from the Autumn Budget and the Trump administration play out. 

If firms pass on higher employment costs through more adjustments to prices than assumed, then inflation is likely to head even higher than the 3.7% the Bank had forecast inflation to reach later this year. If these risks start to materialise and inflation rises more than expected, then the Bank will have a strong case to cut more slowly.  

While we expect an interest rate cut in May, our estimate is that the neutral rate is around 3.5%. This means that if the Bank doesn’t think inflationary pressures have been fully squeezed out of the economy, then there’s a chance they take a prolonged pause in rate cuts later this year.

The interest rate outlook for the second half of the year does look increasingly under threat. Indeed, markets are pricing in just two more cuts for 2025.

Our base case remains three more cuts this year, which would mean interest rates end the year at 3.75%. However, the minutes noted that for the eight policymakers who voted for no change, “there was no presumption that monetary policy was on a pre-set path over the next few meetings”. Translating that from Bank speak, the message is that a cut every quarter is not baked into decision making.