Bank of England Only Has Two More Rate Cuts in the Tank: Analyst

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The Bank of England could already have reached the halfway point of its interest rate cutting cycle.

Hopes for materially lower mortgage and lending rates will be dashed by a new prediction that the Bank of England won't cut interest rates much further.

Following the Bank of England's November policy update, analysis from Berenberg Bank finds the economic backdrop will mean the Bank will have limited options to cut interest rates much further from here.

"Against a backdrop of improved growth and above-target inflation, we forecast that the BoE will keep Bank Rate on hold at 4.25% after two more cuts," says Andrew Wishart, Senior UK Economist at Berenberg.

The Bank of England cut interest rates by 25 basis points on November 07 but released forecasts showing that it thinks inflation will be materially higher in 2025 owing to the government's budget, announced last week.

The budget will see the government borrow substantially more than expected in the coming years to fund a big boost to public spending.

That expectation for higher spending has forced the Bank of England and the Office for Budget Responsibility to raise its near-term GDP growth and inflation projections.

"The MPC called the loosening of fiscal policy announced in the 30 October budget "material news" that pushed up their 2025 GDP growth forecast from 1.0% yoy to 1.5% yoy," says Wishart.

The Bank of England's economists raised their forecast for inflation at the all-important two-year horizon by 60 basis points to 2.2%, which is an admission that the Bank won't achieve its 2.0% target on a sustained basis.

This implies fewer interest rate reductions are required going forward.

"Unlike in August when the BoE’s forecast showed spare capacity emerging and inflation falling below target in 2026, it now projects the economy to be at capacity until 2026 and inflation to stay above the 2.0% target until 2027," says Wishart.

The Bank of England brushed aside October's inflation report that showed inflation fell to 1.7% year-on-year in September, which is well below the Bank's 2.0% target. It thinks inflation will rise from here as favourable developments in energy bills fall out of the comparison data.

The Bank also notes that "disinflation in underlying services prices" was "less pronounced". The Bank is particularly concerned with services sector inflation which is proving reluctant to fall and ultimately means headline inflation will fail to stick to the 2.0% target.

"We continue to think that, with the labour market at capacity, strengthening demand in 2025 will cause inflation to be more stubborn than the BoE anticipates. Against a backdrop of improved growth and above-target inflation, we forecast that the BoE will keep Bank Rate on hold at 4.25% after two more cuts. That marks us apart from the consensus among economic forecasters, which is that interest rates will be reduced to 3.5% by end-2025," says Wishart.

Berenberg's forecasts suggest Bank Rate will fall by less than the market currently anticipates.

This will have implications for lending rates faced by businesses and consumers (higher for longer) and the Pound (also higher for longer).

However, the view is not universal. Analysis from ING Bank suggests the Bank will cut interest rates at a steady clip in 2025.

"The overarching message from the Bank today is that while the budget will have some impact, it is just one of a number of factors affecting the inflation outlook right now. If services inflation continues to fall more meaningfully next year, as many of the surveys seem to indicate, then we think we are still likely to see rate cuts accelerate," says James Smith, Developed Markets Economist at ING Bank.

Current money market pricing shows investors are pricing fewer than three rate cuts from here.

"That would leave UK rates more than two percentage points above the European Central Bank in a year or so. We don’t think that sounds particularly realistic. Our view is that rate cuts will be cut at every meeting from February until rates reach 3.25% next autumn," says Smith.

Gabrielle Dickens, an economist at AXA, also thinks a steady rate of cuts are incoming.

"We continue to expect the Bank to pause in December, before pushing through four 25bps cuts in 2025, leaving Bank Rate at 3.75% by year-end," she says. "The risks in 2026 lie towards further cuts, as demand remains sluggish."

UK inflation data for October will be released on November 20.