The Bank of England (BoE) delivered a first rate cut since 2020 on Thursday, lowering it from a 16-year high after a narrow vote in favor of policymakers divided over whether inflation pressures had eased sufficiently.
Governor Andrew Bailey – who led the 5-4 decision to lower rates by a quarter-point to 5% – said the BoE's Monetary Policy Committee would move cautiously going forward.
"We need to make sure make sure inflation stays low, and be careful not to cut interest rates too quickly or by too much," he said in a statement alongside the decision.
The rate reduction was in line with the forecast in a Reuters poll of economists but financial markets had only seen just over a 60% chance of a cut.
Sterling was little changed and bond yields were slightly lower after the decision.
"Falling U.K. interest rates have arrived at last," Neil Birrell, chief investment officer at Premier Miton Investors, said. "The Bank of England has moved from worrying about inflation ... although they are bound to be cautious about further cuts," he said.
Rates have been on hold for almost a full year – the longest period rates have been left unchanged at the peak of a BoE tightening cycle since 2001 – and this is the first cut in rates since March 2020, at the start of the COVID-19 pandemic.
In June the BoE voted 7-2 to keep rates on hold, and minutes of Thursday's meeting showed the decision to cut rates had been "finely balanced" for some members – echoing the language used previously when rates were kept unchanged.
None of the policymakers whose votes changed the balance at this meeting – Bailey and Deputy Governors Sarah Breeden and Clare Lombardelli – had spoken publicly about monetary policy since the previous meeting in June.
Speaking opportunities had been limited by an election campaign that ended on July 4, which brought the Labour Party to power with a large majority.
The BoE said policymakers had been briefed on the new government's public sector pay and fiscal policy announcements this week, but their impact would only be incorporated into the BoE's forecasts after the Oct. 30 budget.
British consumer price inflation returned to the BoE's 2% target in May and stayed there in June, down from a 41-year high of 11.1% struck in October 2022.
This leaves British inflation lower than in the eurozone – where the European Central Bank (ECB) cut rates in June – and the United States, where on Wednesday the Federal Reserve (Fed) kept interest rates steady but opened the door to a September cut.
However, the BoE expects headline inflation to rise to 2.75% in the final quarter of the year as the effect of last year's steep falls in energy prices fades, before returning to its 2% target in early 2026 and later sinking below.
The long-time lags for interest rates to affect inflation mean the BoE is more focused on what it sees as medium-term drivers of inflation: services prices, wage growth and more general tightness in the labor market.
Services inflation came in well above the BoE's forecasts in June, but the BoE put this down to "volatile components" and regulated prices that were influenced by the high headline consumer price index (CPI) earlier in the year.
Wage growth at nearly 6% is almost double the rate the BoE views as consistent with 2% inflation but is slowing in line with the central bank's expectations.
The BoE now thinks Britain's economy will expand by around 1.25% this year, revised up from its previous forecast of 0.5%, reflecting stronger-than-expected growth during the first half of this year.
Unemployment will rise slightly as high interest rates continue to bear down on growth, the forecasts showed, reducing upward pressure on inflation.
However, the BoE acknowledged the risk that inflation pressures might prove more persistent and keep inflation above target for longer than its main forecast.
Before the meeting, financial markets priced in two quarter-point cuts by the BoE this year. The BoE forecasts were based on market expectations which show interest rates falling to about 3.7% by the end of 2026.
Next month the BoE will also need to decide whether it continues the 100 billion pound a year reduction in its bond holdings built up between 2009 and 2020.
In its report on Thursday, the BoE stuck with its assessment that these sales had a limited impact on the gilt market and that the high level of interest rates gave it scope to fine-tune monetary conditions if the impact proved greater in the future.
The BoE estimated that its bond sales had contributed 0.1-0.2 percentage points to a 2.75 percentage point rise in 10-year gilt yields between February 2022 and June 2024.
