BoE governor expects four UK rate cuts next year as inflation eases

The Bank of England expects four interest rate cuts next year if its outlook for the UK economy bears out, Andrew Bailey said on Wednesday, as he welcomed recent declines in inflation. 

Speaking to the FT’s Global Boardroom conference, the BoE governor said consumer price inflation had fallen more rapidly than policymakers expected a year ago.

When asked about investor expectations, built into its November economic forecast, of four quarter-point rate cuts in the next year, Bailey said: “We always condition what we publish in terms of the projection on market rates, and so as you rightly say, that was effectively the view the market had.

“We’ve been looking at a number of potential paths ahead — and some of them are better than others,” he added.

UK inflation has fallen far from a peak of 11.1 per cent in late 2022, with price growth coming in at 2.3 per cent in October, above the official 2 per cent target.

The BoE has signalled further cuts to borrowing costs after it trimmed its benchmark rate in two quarter-point steps this year to 4.75 per cent, but it is moving cautiously owing to concerns about sticky services inflation.

Bailey said that while a number of different inflation scenarios were possible, the central forecast in the BoE’s latest monetary policy report implied it would pursue “gradual” interest rate reductions.

The BoE governor was speaking as the OECD predicted the BoE would not be able to lower rates as far as counterparts including the US Federal Reserve and the European Central Bank because of the UK’s growth and inflation prospects.

In its latest economic outlook, the Paris-based organisation said UK rates would plateau at 3.5 per cent in 2026 — just above the terminal rate for the Fed, which is expected to be 3.25-3.5 per cent around that time. The ECB is expected to cut its key rate to 2 per cent in late 2025.

The OECD predicted that the UK economy would grow by 1.7 per cent next year and 1.3 per cent in 2026, up from 0.9 per cent this year, despite tax increases in the Autumn Budget.

Inflation will be more stubborn than in many of the UK’s peers, the OECD found. Price growth is set to accelerate from 2.6 per cent this year to 2.7 per cent in 2025, above rates seen elsewhere in the G7, before dipping to 2.3 per cent in 2026, it added. 

Álvaro Pereira, OECD chief economist, told the FT that the shallower path for rate cuts anticipated for the BoE reflected robust domestic demand and extra stimulus from the Budget, in which chancellor Rachel Reeves loosened fiscal policy compared with previous plans.

These factors, along with “some strong but not spectacular wage growth”, meant the BoE did not need to “ease so fast”, Pereira said. Momentum in the UK was positive, the OECD found, with growth set to accelerate next year because of the “large increase in public expenditure”. 

“Headline inflation will remain above target throughout 2025-26, as services inflation remains sticky and the boost in demand from the spending package brings the economy above potential,” the OECD said in its outlook.

In the Global Boardroom interview, Bailey set out the BoE’s three potential outlooks for UK interest rates.

One implied that disinflation was “well embedded”, implying the BoE could cut rates more aggressively. A less encouraging outlook pointed to a “structural change” in the economy, leading to more stubborn inflation and causing monetary policy to remain more restrictive. 

The “central view”, Bailey said, implied that the BoE would have to “lean in a bit harder” to keep inflation on the right trajectory, leading to slower rate reductions than in the first scenario.

The BoE’s latest forecasts, released in November, focused on the middle forecast and were anchored on market expectations for four rate reductions in the next year. Swap markets are currently pricing in three rate cuts by the end of 2025.

The slowdown in price growth so far suggested the UK’s inflation-targeting regime, based on the independence of its central bank, had worked, Bailey said.

“[Inflation] has come down faster than we thought it would. I mean, a year ago we were saying that inflation today would be around 1 per cent higher than it actually is,” he said. “That, I think, is a good test of the regime. The regime could never stop these shocks happening.” 

In its outlook, the OECD stressed the need for “prudent” fiscal policy, with UK public debt seen at above 100 per cent and rising.

“With limited fiscal buffers, possible external shocks that would require fiscal support are a significant downside risk to the outlook”, the OECD outlook said, citing a fresh increase in global energy prices.

“Moreover, persistent price pressures on the back of the strong increase in government expenditure and uncertainty about the degree of slack in the labour market could require the monetary stance to remain tighter for longer,” it added.

Data visualisation by Clara Murray