Bank of England cuts key rate to 4.75 percent as inflation heads back to target

LONDON — The Bank of England cut its key interest rate for the second time this year, but warned that the Labour government’s budget will keep inflation higher for longer than previously expected. 
The Monetary Policy Committee voted decisively to lower the Bank Rate by 0.25 percentage points to 4.75 percent. External member Catherine Mann, typically the most hawkish voice on the MPC, cast the only vote for no change.
But the Bank kept to its line “a gradual approach to removing policy restraint remains appropriate,” warning that it now sees inflation staying above its medium-term target of 2 percent until the second quarter of 2027, more than a year longer than it had expected in August.  
Part of this is down to Chancellor Rachel Reeves’s autumn budget, which promises an extra £70 billion in spending next year. In its new Monetary Policy Report, the Bank wrote that it expects the budget to push inflation up by just under 0.5 percentage points at its peak in a year’s time. The extra spending is also expected to boost gross domestic product by about 0.75 percentage points.
In the short term, though, the inflation picture is looking considerably brighter: in September, the headline rate fell to a three-year low of 1.7 percent. The Bank has accordingly cut its forecast for year-end inflation to 2.4 percent from the 2.7 percent it predicted in August.
“There has been continued progress in disinflation, particularly as previous external shocks have abated,” the Bank said in a statement, acknowledging however that “remaining domestic inflationary pressures are resolving more slowly.”
“We need to make sure inflation stays close to target, so we can’t cut interest rates too quickly or by too much,” said Governor Andrew Bailey.
At his post-meeting press conference, Bailey struck a cautious tone, saying it’s unclear just how the budget will end up affecting the economy.  He pushed back against certain criticisms of Chancellor Rachel Reeves’s plans, though, saying for example that companies might not be able to pass on to consumers the higher costs caused by the expansion of employers’ national insurance contributions. That tax on labor will come on top of another big increase in the National Living Wage.
“There’s a lot that we will learn about the effects of the budget as they pass through,” he said.
In the same vein, he downplayed suggestions that Reeves’s budget had destabilized the market for U.K. government bonds, or gilts, the way that the ‘mini-budget’ of Kwasi Kwarteng under then-Prime Minister Liz Truss had in 2022.
Bailey indicated he considered the rise in gilt yields last week was a natural repricing of expectations, rather than a sign of any structural loss of confidence in the soundness of U.K. public finances.
“The thing we have to watch very carefully is ‘are we then seeing the natural re-positioning of the market and what goes with that … or are we seeing something else?’” he said. “My assessment was ‘no’, we are seeing the natural process working its way through.”
While Reeves’s new budget promises more borrowing, which would normally put upward pressure on yields, Bailey noted that market rates had moved higher across the world recently, driven by factors not specific to the U.K.
A Trump-shaped hole
Conspicuously absent from the MPR was any explicit mention of Donald Trump and his wide-ranging tariff proposals. The Republican president-elect only became the clear winner by the time the Bank had already convened on Wednesday, but he’s been vocal about his desire to renew the trade war he started in his first term in office, floating tariffs of 10 or 20 percent across the board on all of America’s trade partners.
Bailey diplomatically avoided answering any questions on the impacts of possible U.S. tariffs on the British economy, but warned about the risk of global trading becoming more fragmented as the world drifts back into rival blocs. 
Independent analysts have warned that Trump’s plans could raise inflation around the world by stopping the free flow of goods and services. 
“There are a lot of risks attached to fragmentation of the world economy,” Bailey said “but let’s see what happens.”