Bank of England and European Central Bank update: plenty to analyse

Last week saw both the Bank of England and European Central Bank leave rates unchanged. While this suggests little change, bond markets continue to watch closely for signs of movement.

Bank of England: Positive reaction from bond markets

At the Bank of England (BoE) meeting on Thursday, 5 February, the committee voted to maintain interest rates at 3.75%, in what was a highly anticipated decision. Given the now well-established divide amongst members on the committee, and recent improvements in forward looking domestic activity data, much of the focus once again centred on the vote split. The 5-4 split, with four members voting for an immediate 25bps cut, was considerably more dovish than markets had expected: consensus being something closer to 7-2.

As this was a monetary policy report (MPR) meeting, there were plenty of details for the markets to analyse – most notably on growth, the labour market, and inflation. Overall, the BoE still sees activity as subdued due to weaker demand and downgraded its growth forecasts for 2026 from 1.2% to 0.9%, while the forecast for 2027 saw a smaller reduction from 1.6% to 1.5%. On the labour market, unemployment is expected to continue rising through the first half of the year to peak around 5.3% in Q2 2026.

Lastly – and most importantly – was the committee’s, and in particular the Governor’s, view on inflation. Consumer price inflation (CPI) is expected to be around the 2.0% target by April 2026, before rising slightly during the summer months, and dropping again to settle at around 1.7% in Q1 2027 (down from the previous 2.2% forecast) and 1.8% in Q1 2028 (down from 2.1%). This represents a notably more dovish tone than struck previously and we think this should provide some scope for a further reduction in interest rate this year.

Bond markets reacted positively to the decision; yields on shorter-maturity bonds moved lower as the market priced close to two additional 25 bps rate cuts from the BoE by the end of 2026. From that point onwards, the market is pricing hikes. Given the weak economic growth, poor labour market dynamics, and forecasted inflation profile over the next 18 months, we think such rate hikes appear unlikely. In our view, the risk is skewed towards a lower terminal bank rate than is currently priced.

With UK interest rates rate now below the 5.25% peak, shorter maturity gilts relatively well priced for further cuts, and longer-maturity yields still at decade highs, the yield curve is steep. 

After a brief period of strong performance relative to other G10 government bond markets in the final months of 2025, UK politics has once again contributed to rising yields at the longer end of the curve. With UK interest rates rate below the 5.25% peak, shorter maturity gilts relatively well priced for further cuts, and longer-maturity yields still at decade highs, the yield curve is steep. Longer term investors might now consider whether the additional yield on offer from investing across the yield curve is becoming a more attractive investment proposition relative to shorter maturity bonds.

European Central Bank: Balanced was the watchword this time round

It may have been three days after groundhog day, but the February monetary policy meeting of the European Central Bank (ECB) had a distinct feel of déjà vu about it. In line with prior communication and market pricing, key interest rates were kept on hold and the messaging of data dependence, and no pre-committed rate path were very much the key takeaways.

President Christine Lagarde re-iterated that decisions were unanimous, and the medium-term forecasts of inflation remain on course to meet the ECB’s 2% target and therefore they remain in a good place. Acknowledgement was given to a still uncertain outlook, owing to ongoing trade policy doubts and geopolitical tensions, but the message was of both upside and downside risks to their inflation forecasts “ebbing and flowing”, resulting in a broadly balanced outlook.

Once again, emphasis was placed on the ECB being data dependent, but not data point dependent.

Heading into the meeting, much of the discussion was focused on the recent strength of the euro, particularly against the US dollar, and whether this might cause a dovish shift in ECB policy, as it fed through to the inflation numbers. Lagarde rebuffed this, observing that the euro had been gaining in strength against the US dollar since March 2025 (i.e. this was part of a longer-run trend), and any appreciation will already have been factored into their projections – hence there was no need for any adjustment to policy at this stage. Once again, emphasis was placed on the ECB being data dependent, but not data point dependent.

Inflation data for 2026 is expected to come in under target of 2%, but this remains in line with ECB forecasts, with the focus instead on those medium-term projections for 2027 and 2028, where inflation is expected to be at or around 2%.

One journalist tried to get Lagarde to agree that the policy statement could be interpreted as mildly hawkish. This suggestion was quickly rebuffed by Lagarde saying that the bank’s intention is not to be hawkish or dovish – adding that this is something journalists choose to categorise. Balanced was the watchword this time round.

Overall, not a huge amount could be gleaned from this meeting, which is likely what the ECB was looking to deliver. There was no change in messaging, no immediate policy action, no commitment to a particular rate path – nothing to see here! This was borne out by the market reactions, with European government bond yields barely moving over the announcement and subsequent press conference. Attention now shifts back to fiscal plans, increased government spending and bond supply.

For professional investors only. This material is not suitable for a retail audience. Capital at risk. This is a financial promotion and is not investment advice. Past performance is not a guide to future performance. The value of investments and any income from them may go down as well as up and is not guaranteed. Investors may not get back the amount invested. Portfolio characteristics and holdings are subject to change without notice. The views expressed are those of the author at the date of publication unless otherwise indicated, which are subject to change, and is not investment advice.