BOE Cuts Key Rate By 25bps To 4.5%; Est. 4.500%

• BOE Cuts Key Rate By 25bps To 4.5%; Est. 4.500%

The Monetary Policy Committee (MPC) sets monetary policy to meet the 2% inflation target, and in a way that helps to sustain growth and employment. The MPC adopts a medium-term and forward-looking approach to determine the monetary stance required to achieve the inflation target sustainably.

At its meeting ending on 5 February 2025, the MPC voted by a majority of 7–2 to reduce Bank Rate by 0.25 percentage points, to 4.5%. Two members preferred to reduce Bank Rate by 0.5 percentage points, to 4.25%.

There has been substantial progress on disinflation over the past two years, as previous external shocks have receded, and as the restrictive stance of monetary policy has curbed second-round effects and stabilised longer-term inflation expectations. That progress has allowed the MPC to withdraw gradually some degree of policy restraint, while maintaining Bank Rate in restrictive territory so as to continue to squeeze out persistent inflationary pressures.

CPI inflation was 2.5% in 2024 Q4. Domestic inflationary pressures are moderating, but they remain somewhat elevated, and some indicators have eased more slowly than expected. Higher global energy costs and regulated price changes are expected to push up headline CPI inflation to 3.7% in 2025 Q3, even as underlying domestic inflationary pressures are expected to wane further. While CPI inflation is expected to fall back to around the 2% target thereafter, the Committee will pay close attention to any consequent signs of more lasting inflationary pressures.

GDP growth has been weaker than expected at the time of the November Monetary Policy Report, and indicators of business and consumer confidence have declined. GDP growth is expected to pick up from the middle of this year. The labour market has continued to ease and is judged to be broadly in balance. Productivity growth has been weaker than previously estimated, and the Committee judges that growth in the supply capacity of the economy has weakened. As a result, the recent slowdown in demand is judged to have led to only a small margin of slack opening up.

In support of returning inflation sustainably to the 2% target, the Committee judges that there has been sufficient progress on disinflation in domestic prices and wages to reduce Bank Rate to 4.5% at this meeting.

Based on the Committee’s evolving view of the medium-term outlook for inflation, a gradual and careful approach to the further withdrawal of monetary policy restraint is appropriate.

In addition to the risks around inflation persistence, there are also uncertainties around the trajectories of both demand and supply in the economy that could have implications for monetary policy. Should there be greater or longer-lasting weakness in demand relative to supply, this could push down on inflationary pressures, warranting a less restrictive path of Bank Rate. If there were to be more constrained supply relative to demand, this could sustain domestic price and wage pressures, consistent with a relatively tighter monetary policy path.

The Committee will continue to monitor closely the risks of inflation persistence and what the evolving evidence may reveal about the balance between aggregate supply and demand in the economy. Monetary policy will need to continue to remain restrictive for sufficiently long until the risks to inflation returning sustainably to the 2% target in the medium term have dissipated further. The Committee will decide the appropriate degree of monetary policy restrictiveness at each meeting.

1: The economic outlook

Progress on disinflation in domestic price and wage pressures has generally continued. In support of returning CPI inflation sustainably to the 2% target, the Committee is maintaining its focus on the persistence of inflationary pressures in the medium term. It also notes the significant uncertainties around the current and prospective balance of demand and supply in the economy.

CPI inflation was 2.5% in 2024 Q4, close to expectations at the time of the November Report. CPI inflation excluding energy has continued to decline over the past year reaching around 3¼% in the second half of 2024 compared with its peak of nearly 8½% in mid-2023 (Chart 1.1). In large part reflecting recent developments in global energy costs and regulated prices, headline CPI inflation is expected to rise quite sharply in the near term, to 3.7% in 2025 Q3. But the MPC judges that this pickup in headline inflation will not lead to additional second-round effects on underlying domestic inflationary pressures in the forecast (Key judgement 1).

The recent slowdown in demand is judged to have led to only a small margin of slack opening up, as growth in the supply capacity of the economy appears to have been weakening over the past year. Within potential supply, labour supply growth has been strong and potential productivity appears to have been very weak. The MPC considers that the labour market is broadly in balance.

In the February forecast, the margin of excess supply is expected to widen over the next couple of years, to around ¾% of potential GDP, before narrowing slightly by the end of the forecast period (Key judgement 2). The unemployment rate is projected to rise gradually to around 4¾%. Annual potential supply growth is projected to rise to around 1½% in the medium term, which supports GDP growth picking up from the middle of this year, to over 1½% by the end of the forecast period.

There are considerable risks around the path of excess supply in the economy. The Committee has considered carefully the impact of alternative assumptions for the degree to which recent developments in activity may reflect greater weakness in demand relative to supply. It has also considered the more material risk that weakness in the labour market and other uncertainties in the global and UK economies could push down on demand in a longer-lasting way over the forecast period. In the other direction, if there were to be more constrained supply relative to demand, this could sustain domestic price and wage pressures.

Overall, the Committee judges that, while there have been important developments since November, the forecast remains consistent with the second case that it has identified previously regarding the evolution of the remaining persistent inflationary pressures. That is, conditioned on the market path of interest rates, the emerging margin of slack in the economy acts against some continuing second-round effects in domestic prices and wages in order for CPI inflation to fall back to around the 2% target in the medium term (Key judgement 3).

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