Similar to its significance in 2024, the rate at which the Bank of England lowers interest rates in 2025 will be a major topic of interest for financial markets. As we begin the new year, the Bank Rate stands at 4.75 percent, having only lowered interest rates twice this year.
Financial markets predict a similarly sluggish rate of easing in 2025 in response to the most recent data release in December. According to City AM, official data issued the week before Christmas showed that inflation rose to 2.6% in November, meeting forecasts but demonstrating that inflation is still stubborn.
The fact that wage growth outpaced market projections suggests that price pressures will persist for some time. The Bank decided to keep rates the same in December, which is not surprising.
Bank of England guidance
There was little alteration in the Bank's guidance, with policymakers pledging a 'gradual' rate of interest cuts due to numerous uncertainties surrounding the economic outlook. However, the voting split did surprise markets, with three out of the nine members of the Monetary Policy Committee (MPC) advocating for another cut, primarily due to the UK's recent sluggish performance.
GDP figures indicated a contraction of 0.1 per cent in October, marking the second consecutive month of shrinkage. The Bank of England predicts the economy will stagnate in the final quarter of 2024.
Indeed, since the summer, growth has been minimal at best and the Budget hasn't provided much relief for businesses. The Monetary Policy Committee (MPC) noted that the increase in National Insurance Contributions is "weighing heavily on sentiment".
Growth dominates
As we move into the new year, many economists suggest that policymakers will be more influenced by the prospect of slow growth than persistent inflationary pressures. "Although the UK economy is facing significant wage pressures, economic activity is significantly less dynamic than in the US," said Guillaume Derrien, senior eurozone economist at BNP Paribas.
He added: "Between an ECB whose rate cuts will, admittedly, be gradual but steady, and a US Federal Reserve that is now more hawkish, the Bank of England will be in an intermediate position in 2025, with four rate cuts expected in 2025...at a rate of one cut per quarter," Ruth Gregory, deputy chief UK economist at Capital Economics, concurred. "We haven’t changed our view that the Bank will continue to cut rates by 25bps a quarter," she stated.
So why are policymakers more worried about slow growth than signs of high inflation?
The rise in inflation in November was predicted long ago – it was mainly due to base effects – while the MPC pointed out that monthly pay figures can be "volatile". Persistent inflation could still pose a problem for the Bank, but at this point, sluggish growth appears to be the primary concern. Stagnation has already shown up in the official statistics.
Donald Trump’s impact on interest rates
The Monetary Policy Committee (MPC) is facing uncertainty regarding the influence of Donald Trump, particularly on interest rates and how his tariffs might affect the global economy. The specifics of the tariffs remain vague.
"Indicators of trade policy uncertainty had increased materially, but that the magnitude and the direction of the impact of any such policies on UK inflation was at present unclear. These effects might not be apparent for some time," commented the Bank during its last meeting. They indicated that President Trump is poised to significantly affect international trade policy yet refrained from estimating the potential outcomes.
Despite the caution exercised by the MPC, two of its members, Swati Dhingra and Clare Lombardelli, have put forward the idea that Trump's tariffs could lead to reduced inflationary pressures. Both suggest that substantial tariffs on Chinese imports may prompt manufacturers in China to lower prices to maintain their market share.
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