BoE and the Fed: future cuts to be expected

Bank of England

Thursday’s (19 June) Bank of England (BoE) meeting was ultimately a dull affair. As had been widely forecast, the BoE left rates unchanged at 4.25%, while the language regarding the future path for rates was maintained, with a continued “gradual and careful approach to the withdrawal of monetary policy restraint”. And with it being a non-Monetary Policy Report (MPR) month, there was little new information for the markets to digest. That being said, there was a slight surprise in the voting pattern with a 6-3 vote split (six to maintain rates at 4.25% and three for an immediate reduction of 0.25% to 4.00%), rather than the anticipated 7-2 split. However, there was little to no market reaction to this shift. The market remains priced for rates to be reduced further in the second half of the year, with reductions of 0.25% expected at both the August and December 2025 meetings; both are MPR months.

Recent economic data within the UK has continued to support the narrative that base rates remain too high and should be reduced further from here over time. Economic growth remains anaemic at best, with April’s GDP print being particularly weak relative to expectations at -0.3% month-on-month. And regardless of the issues that the Office for National Statistics (ONS) faces with the quality of its labour market data, last weeks’ labour market report was undoubtedly on the weaker side. On the evidence of the HMRC payrolls data, the deterioration experienced in the labour market has accelerated since April, when Labour’s October 2024 budget changed to National Insurance Contributions (NIC) and the hike to the minimum wage kicked in. On inflation, this week’s data was mixed. Consumer Price Inflation (CPI) surprised to the upside at 3.4% versus 3.3% expected, but services inflation fell, surprisingly to the downside, and it is this element of inflation that the BOE will be most focused on.

Our view is that the markets pricing of a 4% neutral rate is too high, and five-year maturity gilt yields above 4% remain an attractive proposition.

With that in mind, further cuts to the bank rate should be expected over the second half of the year. The market is pricing UK interest rates to decline to 3.50% by the end of Q1 next year (three further cuts in total), before gradually rising to a market-implied neutral rate of around 4.0%. For investors in the gilt market, the real debate should be around where that longer-term neutral rate lies. With the global economic environment remaining highly uncertain, and aspects of the UK economy looking particularly challenged, our view is that the markets pricing of a 4% neutral rate is too high, and five-year maturity gilt yields above 4% remain an attractive proposition.

Federal Reserve

At its meeting earlier this week, the Federal Reserve voted to keep interest rates unchanged at 4.25-4.50%. The majority of the Federal Open Market Committee (FOMC) participants continued to hold the view that two further interest rate cuts in 2025 are warranted, however there were some members of the committee that preferred no further rate cuts in 2025. In addition, we saw that theme continue into 2026 and 2027 with the median forecast for interest rates highlighting less interest rate cuts than at previous meetings. Fed Chairman Jerome Powell emphasised that the committee remains ready to flex both sides of its dual mandate if required and the economic forecasts recognised that the path ahead is challenging with growth revised lower, but inflation and unemployment revised up. Time will tell as to the direction of travel, but time is what the Fed still feels it has. With the tariff pause coming to an end and the ‘Big Beautiful Bill’ awaiting approval, it won’t be long before more of the uncertainty subsides. Global conflict continues to swing the inflation barometer to ‘stormy’, however, the Fed feels that this storm is likely to pass fairly quickly and it seems to be less of a concern to the committee over the longer term.

We have seen a significant shift in the shape of the yield curve: the spread between five-year and 30-year treasuries has increased by 40bps to its steepest level in four years

In short, this was a fairly muted meeting and we think that is exactly what the treasury market was hoping for ahead of a long holiday weekend. Treasuries were relatively unchanged on the back of the announcement, as were future expectations of interest rate cuts. The US 10-year government bond yield has been trading in a well-defined range between 4.00% to 4.50% since February 2025 and this is unlikely to change until we see a significant shift in the economic data. By contrast, over the same period, we have seen a significant shift in the shape of the yield curve: the spread between five-year and 30-year treasuries has increased by 40bps to its steepest level in four years. This has less to do with interest rate expectations and more to do with debt sustainability fears. However, both go hand-in-hand and, as long-dated treasury yields continue to rise, this will put further pressure on household borrowing costs and the economy. That may in turn force the Fed to take action on the growth side of its mandate.

We continue to hold a longer duration stance within our portfolios. We have been reflecting this view through non-US global sovereign markets where we particularly favour the UK, Japan, Australia and Spain. If we do make a foray into the US market, we prefer to focus on 30-year US real yields, as these look very good value at 2.60% in our view, particularly in a world where stagflationary fears are abundant.

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