The Bank of England continues on its gradual rate cutting path, but vote adds a little spice

At the Bank of England (BoE) meeting on the 7 August, the committee voted to cut rates from 4.25% to 4%, as was widely expected by the market.

For much of the last 12 months the BoE have stated they will take a ‘gradual and careful’ approach in reducing the restrictiveness of monetary policy, which the market has interpreted as one cut per quarter, at each of the BoE’s Monetary Policy Report (MPR) months. The BoE’s decision to cut rates by 0.25% sustained this narrative. Where the BoE did surprise was on the vote breakdown. In the end, the committee voted by a majority of only 5-4 to cut rates by 0.25% – a much tighter margin than the market had been expecting.

There is no doubt that inflation is the area in which the committee remains most divided and there is clearly some nervousness around its persistence.

With it being an MPR month, there was plenty of detail for the market to focus on, and much of the post meeting press conference was dedicated to inflation. Consumer Price Inflation (CPI) has fallen a long way since its peak above 10% in the summer of 2022, but it has been rising for much of the last 12 months, from its trough below 2% in September 2024. In the short term, peak inflation was revised higher once more, from 3.7% to 4%, largely due to higher food and energy prices; both these areas had been highlighted by the MPC in the prior meeting minutes as being components at risk of putting upward pressure on inflation in the short term.

Looking further out however, inflation is still expected to fall back to the CPI target of 2% by the second quarter of 2027; it should be noted that this forecast is conditioned on the market implied path for rates, which has base rates falling to 3.5% by the middle of next year. There is no doubt that inflation is the area in which the committee remains most divided and there is clearly some nervousness around its persistence given that the MPC judged that the upside risks around medium-term inflationary pressures had moved higher since the prior meeting in May.

For now though, the market’s interpretation is that very little has changed. Whilst gilt yields are a little higher after the meeting, as the market prices out any chance of a September cut, a further reduction in rates of 0.25% at the November 2025 meeting (MPR month) remains well priced. Rates at their current levels of 4% are still judged by the MPC as being restrictive, although to a lesser extent than 12 months ago, and the committee retains its ‘gradual and careful’ approach to cutting rates. As a result, the market still forecasts interest rates to fall to around 3.5% by next year.

All the evidence seems to suggest that growth remains weak, and that the Labour government is under real fiscal pressure. The bond market has already shown that it will not tolerate more government borrowing.

To us, this terminal rate still remains too high given the challenges faced by the global and domestic economy. The MPC have stated many times that they only take into account announced government policy when forecasting future growth and inflation. All the evidence seems to suggest that growth remains weak, and that the Labour government is under real fiscal pressure.

The bond market has already shown that it will not tolerate more government borrowing. So, with fiscal rules to meet, and tax hikes looking like the Chancellor’s only real option, the economic outlook remains challenged. In our view, we think this makes gilts attractive on a risk / reward basis, particularly in shorter maturities.

Whilst September’s meeting is unlikely to impact the gilt market from a monetary policy and interest rates perspective, the MPC is due to update the market on its quantitative tightening (QT) policy for the coming period September 2025 to September 2026. Our view is that the MPC should allow the passive element of its program to continue, but stop active QT altogether. That would see QT slow from the current run rate of £100bn per annum to around £50bn per annum.

However, we ultimately think this might be a step too far, and that the MPC will look for a middle ground which would still allow active sales of around £25bn. Should this be the case, then at the very least, we believe that the BoE should stop active sales of long-dated gilts to lower the risk of even more volatility at the long end of the curve.

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