Bank of England Cuts Rates to 4.75% Amid Higher Inflation Outlook After New Budget

The Bank of England reduced interest rates on Thursday to 4.75%, marking only the second rate cut since 2020. The central bank indicated that further reductions would be gradual, given expectations of higher inflation and slower economic growth following the new government's budget.

The Monetary Policy Committee voted 8-1 in favor of the rate cut from 5%, surpassing predictions in a Reuters poll, which had expected a 7-2 vote. Catherine Mann dissented, advocating for no change in rates.

BoE Governor Andrew Bailey emphasized that keeping inflation near the target was essential, and that interest rates should not be reduced too quickly or by too much. However, he added that, if the economy evolves as anticipated, rates would likely continue to fall gradually.

The Bank of England expects the recent budget, which includes substantial tax increases, higher government spending, and more borrowing, to boost the UK economy by around 0.75% next year. However, the economic growth rate is not projected to see significant improvement over the next two or three years.

The Bank also forecasted that inflation would rise slightly due to the budget’s effects. It anticipated that inflation could peak just under 3% in two years, with a delayed return to the target of 2%. This would likely push the return to sustainable inflation to take a year longer than previously expected.

BoE's cautious stance on future rate cuts aligns with market expectations, which predict gradual reductions compared to the European Central Bank's approach. Financial markets are now pricing in two to three interest rate cuts from the BoE in 2025, a reduction from the previous anticipation of four cuts.

The Bank also projected inflation would rise to 2.5% by the end of 2024 from 1.7% in September and reach 2.7% by the end of next year, before gradually falling below the 2% target by the end of the three-year forecast period.

Several government decisions, including raising the cap on bus fares, increasing VAT on private school fees, and higher social security contributions from employers, were expected to add to inflationary pressures.

The BoE also noted that the higher national minimum wage and rising employer costs might lead to higher inflation, but the overall effect remained uncertain. Employers could respond by laying off staff or accepting lower profits.

Despite reducing its economic growth forecast for 2024 to 1% from 1.25%, the BoE raised its growth outlook for 2025 to 1.5%. This adjustment was due to stronger government consumption and investment, which were expected to counterbalance the effects of higher taxes.

However, the BoE's economic projections do not account for the recent rise in market borrowing costs, which could slightly lower the outlook for inflation and growth. The Bank reiterated that monetary policy would need to remain "restrictive" for a sufficient period to return inflation to the 2% target.

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