There were reasons to be cheerful contained within the Bank of England’s latest verdict on the outlook for the UK economy, released alongside its decision to leave interest rates unchanged at 4%.
Inflation, it said, has now peaked at 3.8%, and is expected to fall steadily back to the Bank’s 2% target sometime in 2027. That’s an improvement on its thinking in August (the last time it published forecasts), when inflation was expected to peak at 4%.
As inflation falls, economic growth picks up from 1.5% this year to 1.8% by 2028.
In the meantime, members of the central bank’s monetary policy committee (MPC),signalled that rates could fall from 4% now to a possible 3% by 2028. That would still be well above the prolonged period of ultra-low rates that mortgage borrowers had become accustomed to in the aftermath of the 2008 financial crisis, when rates fell from 5.5% at the beginning of that year to just 0.5% in March 2009.
The next cut in interest rates could come in December, providing some Christmas cheer for borrowers and coming sooner than financial markets had previously expected.
Given the expected slide in inflation and a weakening jobs market, it might be surprising that a cut was ruled out this month – and it was a close-run vote.
The Bank’s governor, Andrew Bailey, proved to have the decisive vote, making it five members in favour of holding rates at 4% and four in favour of a cut to 3.75%.
Bailey’s decision was most likely based on three factors. The first was that a rate cut today might have been seen as politically helpful for Rachel Reeves in the run-up to her budget later this month. Bank officials do not want to get mixed up in political ding-dongs, especially when Nigel Farage has questioned why the Bank of England should exist in its current form.
A budget can also change the economic arithmetic. All the signalling from the chancellor has been that in the short-term at least, the budget will include quite chunky tax rises, which will only dent consumer demand and bring down inflationary pressures. But Bailey would prefer to wait and see how the mix of budget policies, which could be many, will affect the central bank’s calculations.
And there is the reputation of the Bank of England as a bulwark against inflation – no ifs, no buts. Bailey guards this reputation closely. In the current climate, the governor might feel the Bank needs to be considered extra tough on inflation. After all, we live in a world of populist politicians at both ends of the political spectrum who demand low interest rates as an easy way to improve their popularity ratings.
The US Federal Reserve is considered in many parts of the financial services industry to have caved in to Donald Trump by signalling a more relaxed attitude to high and rising inflation. Bailey will not want to follow suit.
Of course, this is all speculation. Bailey’s official statement said he needed to be sure “that inflation is on track to return to our 2% target” before voting for another cut.
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But this interpretation of Bailey’s decision this month and likely change of heart in December appears to be well founded when set against his comments in recent months.
As for Reeves, if she can navigate the budget and its aftermath, the Bank’s forecasts show that there are sunny uplands ahead.
Next year will be bumpy, with growth slowing to 1.2%, but from 2027, there is a steady expansion that should boost tax receipts and allow the chancellor to ease some of the spending cuts she has pencilled in for the second half of the parliament.
There is always the chance this benign outlook could be blown off course, but the Bank of England’s assessment holds out the prospect of better times ahead.
