The BoE Governor expects the UK to cut interest rates four times next year as inflation eases

The Bank of England expects four interest rate cuts next year if the outlook for the British economy is confirmed, Andrew Bailey said on Wednesday, as he welcomed a near-term decline in inflation. This.

Talking to FT Global Boardroom at the conference, the BoE governor said consumer price inflation had fallen faster than policymakers expected a year ago.

Unlike the Federal Reserve, the BoE does not issue interest rate forecasts. However, inflation and GDP forecasts are based on market expectations about the future direction of interest rates.

Asked about investor expectations, based on November’s economic forecast, of four rate cuts next year, Bailey said: “We always base what we announce on our forecasts.” quote about market interest rates, and as you’re right, that’s really the view that the market has.”

Asked whether, according to the BoE’s central forecast for 2025, the MPC would make four rate cuts, Bailey said “Yes.”

“We are looking at a number of potential paths forward – and some of them are better than others,” he added.

UK inflation has fallen well below its peak of 11.1% at the end of 2022, with price growth at 2.3% in October 2% higher than the official target.

The BoE has signaled further cuts in borrowing costs after cutting its benchmark interest rate in two quarterly steps this year to 4.75%, but the BoE is acting cautiously due to concerns about tough servicing inflation. .

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

BoE Governor spoke in his capacity as OECD predicts the BoE will not be able to lower interest rates as much as its counterparts including the US Federal Reserve and the European Central Bank because of the UK’s growth and inflation outlook.

In its latest economic outlook, the Paris-based institution said UK interest rates will stabilize at 3.5% in 2026 – above the Fed’s final rate, which is expected to be 3.25-3.5% around that time. The ECB is expected to cut its key interest rate to 2% by the end of 2025.

The OECD predicts the UK economy will grow 1.7% next year and 1.3% in 2026, up from 0.9% this year, despite tax increases in the country. Fall budget.

The OECD sees inflation being more stubborn than many of its UK peers. Price growth is expected to rise from 2.6% this year to 2.7% in 2025, above levels seen elsewhere in the G7, before slowing to 2.3% in 2026.

Álvaro Pereira, the OECD’s chief economist, told the FT that the shallower interest rate cut path predicted for the BoE reflects strong domestic demand and additional stimulus from the Budget, which Prime Minister Rachel Reeves has loosened fiscal policy compared to previous plans.

These factors, along with “some strong but not spectacular wage increases”, said Pereira, meant the BoE did not need to “ease too quickly”. The OECD sees momentum in the UK as positive with growth expected to accelerate next year due to “strong increases in public spending”.

“Overall inflation will remain above target throughout 2025-26, as services inflation remains high and increased demand from the spending package keeps the economy above potential,” the OECD said in its outlook. power”.

In his Global Boardroom interview, Bailey laid out three potential BoE outlooks for UK interest rates.

One implied that the reduction in inflation was “well done”, implying that the BoE could cut interest rates more aggressively. The less positive outlook points to “structural shifts” in the economy, leading to more persistent inflation and further restrictive monetary policy.

Bailey said the “central view” implies that the BoE will have to “lean in a little harder” to keep inflation on track, leading to a slower rate cut than in the first scenario.

The BoE’s latest forecast, published in November, focuses on the mid-range forecast and is based on market expectations of four interest rate cuts over the next year. The swaps market is currently pricing in three rate cuts by the end of 2025.

Bailey said the slow pace of price growth so far showed the UK’s inflation targeting regime, which relies on central bank independence, was working.

“[Inflation] went down faster than we thought. I mean, a year ago we said inflation today would be about 1% higher than it actually is,” he said. “I think it’s a good test for the regime. The regime can never prevent these shocks from happening.”

In its outlook, the OECD emphasized the need for “prudential” fiscal policy, with UK public debt above 100% and rising.

“With limited fiscal cushions, possible external shocks requiring fiscal support are risks that significantly dampen the outlook,” the OECD outlook said, citing global energy prices. new increased demand.

“Furthermore, persistent price pressures from strong government spending and uncertainty about the extent of labor market sluggishness could keep monetary policy tight for longer.”

Data visualization by Clara Murray