UK growth has been slowing
The Bank of England has a dual mandate – as well as controlling inflation, it needs to support economic growth. UK growth has been limp for years, particularly since Brexit, but there has been a further slowing in recent months with some commentators issuing warnings about the potential onset of stagflation.
Monthly GDP contracted by 0.1% in January, and grew by just 0.2% on a three-month basis (versus the three months before).
“The Spring Statement is now less than two weeks away, and it is becoming increasingly clear that chancellor Rachel Reeves finds herself in a very difficult position,” said Richard Carter, head of fixed interest research at wealth manager Quilter.
“The Bank of England recently halved its forecast for economic growth from 1.5% to 0.75% in 2025. Given fiscal headroom is highly sensitive to changes in growth expectations, the previous £9.9bn of headroom will almost certainly no longer be available,” he added.
“The government is between a rock and a hard place given its repeated assurances that it will not raise taxes for working people. The alternative is to cut spending elsewhere and take from what are already stretched resources.”
Above: Reeves has previously committed to just one major fiscal event per year, suggesting the Spring Forecast was not intended to be a major 'tax and spend' event. Will she be forced to change her stance?
“UK will also feel the effects as the trade war escalates”
While Trump hasn’t targeted the UK with tariffs so far other than the broader steel and aluminium tariffs, it would be foolish to believe we won’t be affected, experts suggest.
“Given how intertwined the UK is with the global economy, it will also feel the effects as the trade war escalates. Already growth is highly sluggish, only just crawling along by 0.1% in the final quarter of last year,” said Susannah Streeter, head of money and markets at investment platform Hargreaves Lansdown.
“There are hopes of a trade deal between the US and the UK, but given Trump’s capricious policymaking, until any agreement is signed, sealed and delivered, the UK is set to stay vulnerable,” she added.
With this in mind, Streeter believes we will have to wait until May at the earliest for another cut. The MPC doesn’t meet in April, so the next decision after tomorrow will be announced on 8 May.
How much attention will the Bank of England pay to Trump’s tariffs?
Trump’s erratic trade policy has dominated the headlines in recent weeks. Canada, Mexico and China have been the main targets, but the EU has also been slapped with more targeted measures (alcohol tariffs). Steel and aluminium imports from all countries are also subject to a 25% levy.
Trump has backtracked in several places, granting wide exemptions to Canada and Mexico shortly after initial measures kicked in, however significant damage had already been done. There has been a drop in business confidence as firms struggle to prepare for a landscape that is continually shifting, and consumers are bracing for higher prices as tariffs make goods more expensive.
How much attention will the Bank of England be paying to tariffs? Undoubtedly, Trump’s trade policy will be a concern. Tariffs won’t just push prices up in the US – the interconnected nature of the global economy means price pressures will be exported around the world, particularly when US trading partners respond with retaliatory tariffs of their own.
“The risks to the UK economy, and indeed the world economy, are substantial,” BoE governor Andrew Bailey recently told MPs.
That said, it is too early to determine whether tariffs will force the MPC to cut rates more or less quickly. On the one hand, tariffs are likely to push prices up. On the other hand, they could also act as a drag on economic growth.
Above: The president's erratic trade policy has spooked markets and even prompted talk of a 'Trumpcession' in recent days
Recap: What’s the latest with inflation?
Inflation rose by more than expected in January to 3%, up from 2.5% in December. Analysts had been expecting a reading of 2.8%.
The Bank of England has forecast that inflation will rise further this year, hitting 3.7% by the third quarter. It is primarily higher global energy prices that will drive the increase.
Despite this, the Bank isn’t overly concerned about the forecast currently, given that significant progress has been made with domestic price pressures. The MPC also expects the rise to be temporary.
Speaking at the February MPC press conference, BoE governor Andrew Bailey said: “While we expect inflation to rise again over the coming months, it is almost entirely due to factors that are not directly linked to underlying cost and price pressures in the economy, and factors that we expect to be temporary.”
That said, there are still some risks on the horizon. April’s increase to employers’ National Insurance contributions and Donald Trump’s erratic trade policy could both push prices higher.
Above: UK inflation rose to 3% in January. The next CPI report covering February will be published on 26 March.
Reuters poll: strong likelihood of a “hold”
All 61 economists polled by news agency Reuters last week said they expect rates to hold steady at 4.5%.
A poll of MoneyWeek readers was more split. Sixty-six percent of readers expect no cut (165 out of 250), while 34% expect a reduction (85 out of 250).
The longer-term outlook for rates
Consultancy Capital Economics is expecting three further interest rate cuts this year, and one in early 2026, taking the base rate to 3.5% rather than the 4% being priced into markets. A lot will depend on future inflation reports, though.
“What happens beyond March depends on a whole host of factors, but will largely boil down to how far inflation rises, if that prompts any second-round effects in the form of higher-than-otherwise wage growth and inflation expectations, and the weakness of the economy,” said Paul Dales, the consultancy’s chief UK economist.
He outlines three broad scenarios:
- If inflation rises beyond the 3.7% peak, the Bank will likely pause its rate cuts. “A pause after another two 25 basis-point rate cuts is similar to the scenario priced into the markets,” says Dales.
- Alternatively, slowing inflation might prompt a faster rate-cutting approach.
- If inflation is essentially as expected, the MPC’s current gradual approach will likely continue. This scenario, says Dales, is closest to Capital Economics’ forecast.
How dovish is the MPC?
While Dhingra and Mann both voted for faster cuts at the last MPC meeting, Paul Dales, chief UK economist at Capital Economics, cautions against reading a dovish stance into its approach to this meeting.
Referring back to the BoE analysis published alongside February's decision, he said: “The MPC as a whole placed ‘greater weight’ on scenarios in which both inflation and interest rates fall slower and the Bank dramatically revised up its forecast for CPI inflation.”
The MPC now expects inflation to peak at 3.7% in the third quarter.
Dales adds that the MPC’s emphasis on a “gradual” approach to interest rate cuts implies a 25 basis-point cut every other meeting. What’s more, in February, the committee for the first time indicated that it would be “careful” in its approach, implying that “there are both upside and downside risks to inflation”.
In other words, the MPC still thinks an easing in underlying inflation will allow it to reduce rates to less restrictive levels, but it doesn’t have enough confidence in that assessment to cut rates more quickly, Dales suggests.
Above: The MPC is not as dovish as February's vote might suggest.
Interest rates: which way will MPC members vote?
At the MPC’s last meeting, the nine-person committee voted 7-2 in favour of a 25 basis-point interest rate cut, to 4.5%. The two members who voted against the proposition – Swati Dhingra and Catherine Mann – both favoured a more aggressive 50 basis-point rate cut.
The pair are widely expected to vote for a cut at the upcoming meeting, but will probably be outvoted by their fellow committee members, given inflationary pressures.
“We anticipate a 7-2 vote, with Dhingra and Mann supporting a cut, while the majority opts to hold steady for now,” said Steve Matthews, investment director at Canada Life Asset Management.
This echoes Deutsche Bank economist Sanjay Raja’s view: “The core of the committee has signed up to a 'gradual', 'careful', or 'cautious' calibration of monetary policy,” he says, which he views as more consistent “with a quarterly pace of rate cuts until uncertainty wanes or downside risks in the activity/inflation data emerge”.
He adds that “both Dhingra and Mann are likely to vote for a more 'forceful' rate cut given their views of demand-based weakness emerging in the UK economy, including more downside risks around inflation and wage growth”.
Above: In February's meeting, external MPC member Catherine Mann voted for a 50 basis-point cut, having previously voted to hold rates at December's meeting.
Interest rates expected to be held
Last time the Monetary Policy Committee (MPC) met (6 February), it voted to lower the base rate from 4.75% to 4.5%.
Anyone hoping that the upcoming meeting might bring another fall in interest rates is likely to be disappointed.
“We expect a largely uneventful affair at the March MPC meeting. The path ahead will be one of careful calibration,” said Sanjay Raja, senior economist at Deutsche Bank. “Uncertainty remains elevated. Growth has seemingly turned a corner… Price momentum, at least on a headline basis, points to more upward pressure – at least in the near term.
“We expect Bank Rate to remain unchanged at 4.5%.”
Above: The sun might be shining in London this week, but interest rates are expected to be kept on ice.
Good Wednesday morning. Welcome to our interest rates blog. We will be bringing you live updates on the Bank of England’s key decision tomorrow, starting with preview analysis today. Stick with us.