Bank of England – High inflation expectations to keep rate cuts slow and gradual

The market clearly focused on the more hawkish aspect of the division on the MPC, with gilt yields rising and markets pricing a lower probability of back-to-back rate cuts (for instance, pricing for a June cut fell from around 60% to 20%). Markets probably reacted this way as today’s vote represented a shift from the more dovish voting patterns in recent meetings. Indeed, most interesting was Catherine Mann’s reversion to her old hawkish ways following a brief flirtation with a 50bp rate cut vote in February. As we had argued at that time, her shifting vote pattern seems to be a response to changes in financial conditions. Back then, gilt yields had spiked, leading to an unwarranted tightening of financial conditions that needed to be offset by monetary policy. At this meeting it was noted that ‘short-end market interest rates had already eased by around 40 basis points since the MPC’s previous meeting’, therefore partly justifying the dissent to keep rates unchanged. The other justification was that household inflation expectations had recently risen, and keeping rates on hold would “ensure that monetary policy remained sufficiently restrictive to weigh against stubborn inflationary pressures.”

Indeed, in the Bank’s quarterly Monetary Policy Report – also released today – Bank staff published an analysis of household inflation expectations, which suggests households have become more sensitive to rises in inflation, with a higher risk therefore of second round effects than in the past. While the Bank staff conclude that they expect only limited second round effects from the looming pickup in inflation in its forecast, we have long been concerned at the level of inflation expectations in the UK, which even before the recent rise remains well above that of other advanced economies.

In contrast, the two members voting for a 50bp cut appeared much more confident that stubbornly high wage growth would come down more quickly, and also seemed more worried about the hit to growth from US tariffs and the policy uncertainty surrounding it. Even with today’s US-UK trade agreement, the UK remains vulnerable to spillover effects from trade policy elsewhere, and the uncertainty itself is also a drag on the economy.

All told, while uncertainty is high and the growth shock from US tariffs and uncertainty could be bigger than we assume, on balance we think that stubbornly high inflation expectations will keep the MPC cutting at a slower, quarterly pace, with Bank Rate settling at 3.5% by early 2026.