The Bank of England reduced its benchmark interest rate to 4.0% on Thursday but reinforced a cautious approach in policy as inflationary pressures increase alongside weakening UK economic performance.
In a narrow 5-4 vote, the Bank's monetary policy committee (MPC) opted for a 25 basis point reduction from 4.25%, citing signs of continued disinflation and subdued economic growth.
The decision, which followed the MPC holding rates steady at the last meeting in June, continues a year of gradual policy loosening after the UK’s aggressive tightening cycle in response to post-pandemic inflation spikes.
While headline CPI inflation ticked up to 3.5% in the second quarter due to higher energy and food prices, the Bank now expects it to peak at 4.0% in September, an increase from its previous forecast peak of 3.7% in that same month.
Pay growth remains elevated but has slowed recently and is forecast to moderate further through the year.
Underlying GDP growth has stayed soft, with slack emerging in the labour market. Services inflation has remained steady, while risks around economic activity and geopolitical uncertainty persist.
The MPC said it remains “focused on squeezing out any existing or emerging persistent inflationary pressures” and warned that despite progress, the outlook remains finely balanced.
The committee reiterated that a "gradual and careful" approach to eading monetary policy restraint remains appropriate in its view.
"The timing and pace of future reductions in the restrictiveness of policy will depend on the extent to which underlying disinflationary pressures continue to ease.
"Monetary policy is not on a pre-set path, and the Committee will remain responsive to the accumulation of evidence."
Inflation and growth forecasts updated
The BoE committee's new forecasts signal slightly stronger growth but persistent labour market softness.
The latest set of forecasts show inflation remaining slightly higher over the short term than previously expected.
The Bank now sees CPI peaking at 4.0% in September (up from 3.7% in the May forecast), then gradually easing to 2.7% in one year’s time (up from 2.4%) and unchanged at 2.0% in two years’ time.
Private-sector wage growth is expected to slow more gradually, with 3.75% in 2025 still expected, but estimates for 2026 and 2027 nudged up to 3.25% and 3.0%.
GDP growth for 2025 is seen at 1.25%, slightly firmer than the 1.0% previously projected and with 2026 forecasts unchanged, while the unemployment rate is expected to rise to 4.9% in Q4 this year (up from 4.7%) and remain there next year (down from 5.0%).
Reaction
The FTSE 100 fell slightly and the pound jumped 0.5% against the dollar and euro on the back of the decision.
Policymakers are still playing a "highly cautious" hand, said Susannah Streeter, head of markets and money at Hargreaves Lansdown.
"Although the Bank has opted for a cut, the chances of another reduction by the end of the year have receded sharply."
Neil Wilson, strategist at Saxo, says he is "bamboozled by this one," with no-one expecting this particular vote split.
"A cut of 25bps as expected but the 5-4 split has upset the market assumptions, sending sterling sharply higher and the FTSE 100 down some more.
"Sterling was bid up as the front end of the gilt yield curve drove higher as markets repriced futures. Not sure if sterling can retain this bid though as I feel the BoE is giving us a bum steer."
He says the vote split is "not very often a great signal of future policy and rather reflects a lack of consensus on what remedy is needed in the here and now".
While lots of economists and others thought the BoE should be upping the pace of cuts, instead today's statement has "pushed back cut expectations", says Wilson, with the market now not seeing another 25bps cut priced until March.