UK and US rate decisions: BoE cuts rates as expected, Fed moves along unchanged

Two central bank meetings this week saw two different decisions on rates. The Bank of England (BoE) cut UK interest rates to 4.25%, while the US Federal Reserve (Fed) maintained its rate target range at 4.25% to 4.50%.

The economist view – Melanie Baker, Senior Economist

The BoE has been on a gradual rate cut path, and the data since the last meeting effectively wasn’t enough to move them off that path. Therefore the 25bps rate cut to 4.25% was very widely expected.

Expectation of a more dovish tone to the meeting will have been disappointed: There was some probability going into the event that the Bank of England would move away from its “gradual” rate cutting language and at least open the door to faster rate cuts – especially since this was the first press conference and the first policy meeting since Trump’s April tariff announcements, with all the implications those have had for global growth. I think US tariffs will prove disinflationary not inflationary for the UK economy.

In the event, however, they stuck to their “gradual and careful” language and two Monetary Policy Committee (MPC) members voted for unchanged rates (albeit two other members voted for a 50bps rate cut). Of the five who did vote for a 25bps rate cut, the minutes noted that prior to recent global developments “most members in this group had judged that this policy decision would be finely balanced between no change in Bank Rate and a further reduction” (my italics). The BoE’s MPC often records split votes, but the five-to-four vote was more split than I would have expected. Arguably though it reflects another theme of today’s meeting – uncertainty.  With significant uncertainty around the outlook for both domestic and global reasons it should perhaps not be so surprising that different MPC members were able to come to different decisions on the appropriate stance for policy.     

The Bank of England remains worried about inflation persistence but also about the potential for weaker demand (and for that to weigh on inflation).

As well as “gradual”, they had also been promising to be “careful” against a backdrop of considerable uncertainty around the inflation and broader economic outlook. They remain worried about inflation persistence but also about the potential for weaker demand (and for that to weigh on inflation).

Central forecast – a bit lower for inflation and mixed for growth: Using a market profile for interest rates that sees cuts down to 3.5% in 2026 (from 4.25% today), their central GDP growth forecast was revised up in the near term, but down a bit next year. Their CPI inflation forecast was a bit lower at 1.9% in three years’ time. Crudely, that suggests a central case where rates are gradually cut to 3.5% and isn’t far off the mark in terms of what they’d envisage. But given how uncertain the outlook is and their more scenario-based approach now, I am not inclined to take much of a message from their central forecast.

They do lay out an estimate for the impact of tariffs on the UK economy, but the impacts are relatively modest even before today’s trade deal: 0.3% off GDP (the peak impact in three years’ time) and 0.2% off inflation (the peak impact in two years’ time). In explaining why the impacts were relatively modest, they pointed out that the direct impact and the impact through uncertainty was somewhat offset by the impact of related moves in financial markets.

Strong elements of data dependence and wait-and-see about the outlook for policy: Especially in terms of the impact of President Trump’s policies on global growth, and ultimately on inflationary pressure, things are still uncertain. The MPC don’t seem to be convinced on the directional impact of global tariffs on UK inflation; they see a risk that disruption to supply chains might result in an inflationary impact. There are also plenty of domestic sources of uncertainty for the MPC to digest too. They are still watching how the rise in employers’ NIC tax hike plays out for example. There remains uncertainty around the outlook for productivity growth. There was understandably then still an underlying sense of “wait and see” about the decision today. They remain in a rate cutting stance (“a gradual and careful approach to the further withdrawal of monetary policy restraint remains appropriate”) but “the Committee will continue to monitor closely the risks of inflation persistence and what the evidence may reveal about the balance between aggregate supply and demand in the economy” (my italics). Policy is “not on a pre-set path. The Committee would remain sensitive to heightened unpredictability in the economic environment and would continue to update its assessment of risks” (my italics).

US-UK trade deal is welcome for the UK growth outlook. Writing before details are announced and based on press reports, it looks set to reduce the direct impact of Trump tariffs on the UK economy and some of the uncertainty too. However, Governor Bailey emphasised that as an open economy, the impact of Trump tariffs on other trading partners was important. Breaking news on the deal was too late for the Bank of England to have taken into account in their actual decision today though and Governor Bailey was clear that they had not been briefed on the content. 

Bailey gave some insight into his own views…and was a bit undecided: Governor Bailey said that he was a bit more confident that pay growth was likely to cool than he had been but also said he wasn’t particularly decided one way or another.

Rate path expectations: My central case pencils in two more rate cuts from the Bank of England this year, i.e. it sees the Bank continuing on a gradual path with the next rate cut in August rather than sooner. Today’s decision and press conference did not give me cause to change that central forecast, but with so much uncertainty around the economic outlook, there remain significant risks to that central case.

The fund manager view – Craig Inches, Head of Rates & Cash

Bank of England: Dovish, but not as dovish as the market

For some time, the market has been expecting the BoE’s Monetary Policy Committee (MPC) to ease rates at a gradual pace; most likely quarterly, and at a Monetary Policy Report (MPR) meeting. And that is what the BoE delivered. However, the narrative around the pace of interest rate cuts, and where the terminal rate might land, has shifted somewhat in recent weeks. Much of the pre-meeting market discussion had been around a deteriorating economic growth backdrop, driven both by domestic factors, and increased global pressures stemming from US trade policy. The thought was that growing risks to global growth would allow the MPC to alter their communication away from being “gradual and careful”, opening up the possibility of faster and deeper cuts. Going into the 8 May meeting, a 0.25% reduction in rates had been fully priced by markets, with a further reduction of 0.25% at the next meeting on 19 June priced at around 50% probability. Ultimately, this proved too optimistic. The vote split, and the language in the minutes suggested the likelihood of back-to-back cuts was low; a “gradual and careful” approach was maintained, while the 2-5-2 vote split (two voting for an immediate reduction of 0.5%, five voting to reduce rates by 0.25%, and two voting to leave rates unchanged) suggests the MPC remains more divided than the market thought. Importantly though, the MPC still considers UK interest rates to be in restrictive territory, and although it appears split on what the likely path is from here, further reductions to base rates, at a quarterly pace, look consistent with their central scenario.

Long real yields could provide some protection in an environment where inflation remains sticky.

One area where there was consensus within the MPC, was that the outlook for the global economy remains highly uncertain, particularly with regards to inflation. Within its latest forecasting round, the BoE has revised its expectations for inflation lower, with peak inflation now expected to be 3.50% in Q3 2025, down from 3.70%, before falling to 1.90% (below target) by Q2 2027. Forecasts for UK GDP remained largely unchanged from the prior MPR, with growth revised up a little in the near term, but a little lower next year. Those forecasts are conditional on base rates being reduced to 3.50% by Q2 2026. For much of the last 12 months, we felt that the front end of the UK gilt market has looked attractive, under-pricing the magnitude of potential rate cuts needed to support the UK economy as growth slows and inflation gradually falls back towards target. But with five-year gilt yields currently 70 bps lower than their January peak of 4.60%, and markets pricing base rates below 3.50% by year end, I think that valuations look less attractive. Our preference has shifted to longer maturity assets, particularly longer maturity real yields in both the UK and US. Long real yields could provide some protection in an environment where inflation remains sticky by outperforming nominal bonds on a like-for-like maturity basis but also benefit if growth remains weak and yields fall. In the UK, long-term real rates on UK index linked bonds are above 2.0%, versus the UK economy growing sub 1.0% in real terms. Furthermore, recent announcements from the UK Debt Management Office (DMO) have seen long UK nominal bond issuance slashed from 18.0% in 2024-2025 to around 10.0% in 2025-2026, which should be supportive over the medium term.

Federal Reserve: Move along and nothing to see here

At its meeting on 7 May 2025, the Federal Reserve left rates unchanged at 4.25% - 4.50%. This was in line with expectations and the market was looking for some clues from Chairman Powell as to the future direction of travel. However, the forward guidance, or should we say lack of forward guidance, was the only real takeaway from the accompanying press conference. He emphasised that the uncertainty of the outlook has “increased further”, while the balance of risks statement now acknowledges that the dual mandate goals are likely to come into conflict, indicating that “the risks of higher unemployment, a slowdown in economic growth and higher inflation have risen”. But he balanced this statement by saying that the policy rate is in “a good place” and that it’s a “good time to be patient”. He stated that the Fed could react quickly if appropriate but cautioned that if the newly announced tariffs remain in place, then the Fed will not make progress on their inflation goals this year.

In short, the summary is move along and there is nothing to see here…until we get more clarity on the 90-day tariff pause. There were no fireworks from Trump commenting about Chairman Powell and the market could not get the pulses racing either. The two-year and five-year treasury yields were broadly unchanged post the decision, with the curve marginally steeper and breakevens marginally lower. Even the forward expectation of interest rates was unchanged at 3.25%. So, in a time of uncertainty and heightened market volatility, I think the Fed and Chairman Powell did a good job of keeping market gyrations to a minimum. However, the market is still priced for four interest rate cuts over the next 12 months. This could be interpretated as the market largely ignoring the meeting and holding its view that an economic slowdown is coming and that the Fed will be forced to cut in the second half of this year…it seems that the ball is back in President Trump’s court.

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