In the lead up to Christmas, the Bank of England sent borrowers and businesses an early Christmas gift by announcing an interest rate cut, reducing interest rates from 4% to 3.75%. This is in fact the sixth cut since August last year, but it was a close-run decision by the Bank’s Monetary Committee and was only passed by the narrowest of margins, with a majority of 5 to 4 to reduce the bank rate by 0.25%.
What was the Chancellor’s reaction?
Rachel Reeves was quick to respond to the Bank of England’s interest rates decision. In a statement Dear Rachel said: “This is the sixth interest rate cut since the election. That’s the fastest pace of cuts in 17 years – good news for families with mortgages and businesses with loans.”
After the UK’s sluggish economy shrank by 0.1% in October, the government needed some good news. The BofE’s vote came only three weeks after the Autumn Budget which included one-off reductions to regulatory costs levied on peoples’ energy bills. The BofE said these Budget measures, together with the recent fall in inflation, have led them to predict that inflation will move closer to 2% in the Spring of 2026.
Disinflation is clearly happening
To those of you who have never heard of the term, disinflation is a slowdown in the rate of price increases, meaning inflation is still happening but at a slower pace than before, like going from 10% to 3% inflation. It’s different from deflation, which is a scenario in which prices actually fall.
The BofE’s governor Andrew Bailey, said that disinflation was more established and that the Consumer Prices Index (CPI) had fallen from its peak. He was however, concerned that the Bank’s 2% inflation target may be difficult to maintain because of slack in the economy, largely caused by the rise in unemployment.
Inflation pressures persist
The governor expressed his opinion that inflation predictions had not yet shifted down sufficiently after several years of persistent above-target inflation. He was also concerned that looking forward, that wage-growth demands indicators, such as the BMA’s demand for a 29% pay-rise for resident doctors, were hard to reconcile with the downward momentum in wage inflation, combined with rising unemployment.
Because inflation remains above target, the cut was a very close call. Four of the nine MPC members voted to maintain the Bank Rate at 4% because of their concerns about the upside risks to inflation, despite the growth and inflation data softening since November. MPC member Clare Lombardelli pointed out that underlying inflation is still well above the 2% target rate and that the Budget’s effect of reducing it may not be enough to rein-in underlying pressures largely caused by higher taxes and wage rises.
The rate cut was not a surprise
The interest rate cut appeared inevitable after previous MPC meetings in September and November, when the Bank Rate was narrowly held at 4%, with the committee members voting 5 to 4 on both occasions to keep the rate at 4%.
Back then, Andew Bailey, whilst recognising promising CPI data, voted to maintain the Bank Rate because labour costs remained high and he wanted to see if disinflation was likely to continue, which it did. In fact, last week the inflation rate fell to 3.2%, the lowest level in eight months.
Accountant’s view
The Bank Rate cut was not a surprise, because the Monetary Policy Committee had clearly ben agonising for several months as to whether or not to ‘stick-or-twist’, but it was clearly a narrow victory margin for those members who decided to hold their noses and twist.
The million-dollar question is, will the Bank’s prediction of a reduction in the inflation rate to their target figure of 2% by the early summer of 2026 be achieved or will the resident doctors et all throw a spanner in the works?
Watch this space for the answer!
