Projected UK Interest Rates in 5 Years: GDP Surprising Decrease Won’t Change BoE’s Rates Policy
- The Bank of England cut interest rates in its February meeting.
- However, two monetary policy committee members voted to cut rates by 50 basis points.
- Rates play a fundamental role in tackling high inflation.
- How do interest rates influence cryptocurrencies?
At its February meeting, the Bank of England lowered interest rates by 25 basis points, as expected, with two members pushing for a larger cut.
The MPC voted 7-2 in favor of the quarter-point reduction, bringing the bank rate down to 4.50% from 4.75%.
All members agreed on a rate cut, but two members, Swati Dhingra and former ‘hawk’ Catherine Mann, preferred a 50 basis point reduction to 4.25%.
Following an unexpected contraction in the U.K.’s economic activity in January, investors are now closely watching how the BoE will navigate its next monetary policy moves.
U.K. Economy Unexpectedly Worsens in January
The U.K. economy unexpectedly shrank at the start of the year, with minor service sector growth outweighed by declines elsewhere.
The Office for National Statistics (ONS) reported a 0.1% GDP contraction in January from December, defying expectations of a 0.1% rise. This followed 0.4% growth in December. The ONS attributed the decline mainly to a fall in the production sector.
Services output edged up 0.1% in January after 0.4% growth in December, while production output fell 0.9%, reversing December’s 0.5% rise. Construction output dipped 0.2% for the second consecutive month but grew 0.4% over three months.
January’s production decline was worse than the expected 0.1% drop, reaching its lowest level since May 2020. Annually, production fell 1.5%, easing from December’s 1.9% drop but missing forecasts of a 0.7% decline.
Analysts React
Danni Hewson, AJ Bell’s head of financial analysis, told CCN, “As surprises go, it’s a pretty unwelcome one, but when you’re talking about an economy bouncing along the bottom, the big picture doesn’t really change that much.”
“The U.K. is struggling to find the key to the growth that the government says is a priority if people are going to start to feel better about their own financial lives.”
According to James Smith, Developed Markets Economist at ING, “For the Bank of England, the recent run of data, including today’s weakness in January GDP, is unlikely to have shifted the dial materially ahead of its meeting next week.”
In general, the committee seems to be getting a little more cautious for Smith in light of sticky wage growth and services inflation.
“The major question mark, both for the BoE and the growth outlook generally, is what impact the big tax hike on employers next month will have on the jobs market, which has already cooled significantly over recent months. A spike in layoffs, which so far hasn’t happened, could be a game changer for the 2025 growth outlook and for monetary policy,” Smith added.
Inflation Back to 3% in January
U.K. consumer price inflation rose more than expected last month, according to data from the Office for National Statistics.
The ONS reported that annual inflation climbed to 3.0% in January, up from 2.5% in December, surpassing the FXStreet consensus estimate of 2.8%. This marked the steepest annual increase since March 2024, when inflation reached 3.2%. A year earlier, in January 2024, the rate stood at 4.0%.
The ONS highlighted that rising transport costs, along with higher prices for food and non-alcoholic beverages, were the main drivers of inflation, while housing and household services exerted the biggest downward pressure.
Core inflation, which strips out volatile items such as energy, food, alcohol, and tobacco, rose to 3.7% in January from 3.2% the previous month. Meanwhile, service sector inflation accelerated to 5.0%, up from 4.4%.
On a monthly basis, consumer prices dipped 0.1% in January, following a 0.3% increase in December. This decline was smaller than the 0.3% drop economists had predicted, according to FXStreet.
Impact on BoE Policy
Janet Mui, head of market analysis at RBC Brewin Dolphin, said: “January inflation data and wage data highlight the persistence of price pressures in the UK.”
“The Bank of England has already pencilled in a reacceleration in inflation this year, so this should not come as a surprise to policymakers. At the margin, it is a reminder for the Bank to proceed with caution in terms of rate cuts.”
According to Mui, the pickup in inflation in January was mainly driven by airfares, motor fuels and higher private school VAT. There were some base effect, temporary and one-off factors at play.
“The Bank of England has factored in higher inflation in 2025 mainly due to household bills, so the development is within expectations. Meanwhile, there were weak price pressures in categories like clothing and household goods, which could be symptoms of cautious discretionary spending,” he added.
For James Smith, Developed Markets Economist at ING, “We think the measure of ‘core services’ can dip below 4% within the next couple of months, while overall services inflation could be there by the summer.
“Crucially, that’s a faster fall the Bank of England is currently forecasting. Huge chunks of the services basket are subject to annual price hikes in April, which owing to lower headline inflation, should be less aggressive than they were in April 2024.”
“If we’re right, that wouldn’t necessarily speed up the pace of rate cuts, but it would help cement a total of four cuts this year. We also expect rates to fall to 3.25% in 2026, which is a fair bit lower than markets are currently pricing,” Smith added.
Rate Cut Meets Market Expectations
The MPC noted sufficient progress in disinflation to support the cut and emphasized a “gradual and careful approach” to further easing of monetary policy.
The BoE acknowledged weaker-than-expected economic growth and declines in business and consumer confidence but expects GDP growth to pick up in the second half of the year.
The MPC assessed that this cut would not trigger additional inflationary pressures.
The BoE highlighted risks related to inflation persistence and uncertainties around demand and supply, which could impact future monetary policy.
“If demand weakness persists relative to supply, inflationary pressures could ease, leading to a less restrictive approach,” the BoE stated.
The BoE also mentioned a “rapidly evolving situation” on tariffs, which it will continue to monitor.
Stagflation Alert
Laith Khalaf, head of investment analysis at AJ Bell, said: “The most striking announcement from the Bank of England[…] is not the cut in interest rates, but the prospect of inflation rising to 3.7% this year while its forecasts show the economy continuing to flirt with recession.”
For Khalaf, “CPI at 3.7% is nowhere near the double-digit inflation we saw at the height of the cost of living crisis, but it adds to the cumulative load of price rises.”
“It also sets up the potential for a round of higher salary negotiations, and with wage growth already running hot, this might stoke further inflationary pressures.”
“The Bank can control these by keeping interest rates higher, which would mean more sustained pain for mortgage borrowers and for companies refinancing debt,” the analyst added.
“The market is still pencilling in two interest rate cuts by the end of this year, but beyond that rates are expected to remain pretty steady at around 4% for the next couple of years.”
Rate Cut Bets Rise
Danni Hewson, head of financial analysis at AJ Bell, called the latest inflation figures a “welcome respite” after recent turbulence in U.K. financial markets.
“Today’s numbers will offer some much-needed relief,” she told CCN, noting that the odds of an interest rate cut at the Bank of England’s next meeting have jumped from 60% to over 80% since the data release.
Hewson also pointed to growing optimism that further cuts may be on the horizon for 2025. A notable drop in service sector inflation has fueled these expectations, as central bankers have been wary of the impact of rising wages on this vital part of the U.K. economy.
However, Hewson cautioned against excessive optimism, warning that inflation could surge again if businesses pass on rising costs as they’ve indicated they might in April. “It’s crucial not to overstate the significance of today’s numbers,” she said.
She also highlighted the ongoing risks from global trade tensions, particularly those linked to U.S. tariffs, which could introduce further volatility. While rate cuts may seem more likely, Hewson noted that underlying weaknesses within the U.K. economy largely drive them.
U.K. Consumer “Spending Squeeze”
The British Retail Consortium (BRC) cautioned that consumer confidence in the U.K. economy has taken a significant hit this month, signaling a potential “spending squeeze” as 2025 begins.
According to the BRC’s December consumer spending monitor, public confidence in the economy declined notably, with personal spending plans also showing a downturn.
The data, drawn from a survey of 2,000 U.K. adults conducted in partnership with Opinium between Dec. 10 and 13, highlights growing financial pessimism.
The personal financial situation index held steady in negative territory at minus 3 points, but the index tracking perceptions of the economy plummeted to minus 27 in December from minus 19 in November.
Similarly, the overall personal spending index dropped from positive 3 points to negative 3.
“Spending intentions across retail and other sectors fell by 6 points. Anticipated spending declined across almost every retail category,” said BRC Chief Executive Helen Dickinson. “If these expectations materialize, retailers could face a New Year spending crunch just as they launch their January sales.”
Dickinson also noted that weak consumer demand, coupled with £7 billion in additional costs from the 2025 U.K. government budget, could make the coming year particularly challenging for retailers.
Goldman’s Expectations for the U.K. Economy
One of the primary reasons for Goldman Sachs’ revised outlook is the expectation of a cooling in U.K. wage growth in the coming months. This suggests that inflationary pressures may ease sooner than anticipated. It would allow the Bank of England to adopt a more accommodative monetary policy.
Goldman Sachs has revised its outlook for U.K. services inflation, anticipating a significant deceleration in the coming months. This key factor could enable the Bank of England to achieve its target of 2.0% inflation.
The investment bank expects services inflation to fall 5.0% by December, 0.3% below the BoE’s August forecast. Goldman Sachs further predicts that services inflation will continue to decline, reaching 3.8% by the end of 2025.
Stehn noted that progress in reducing underlying services inflation, excluding rent and education, will likely reassure the MPC that price pressures are easing.
Additionally, Goldman Sachs’ calculations suggest that the U.K.’s terminal interest rate, the level at which interest rates are deemed appropriate, is lower than in other comparable economies. This indicates that the BoE has more work to do regarding interest rate cuts.
The investment bank has assigned a 40% probability to its updated baseline expectation, a 30% probability to quarterly rate cuts, and a 20% probability to a more aggressive cutting cycle with 50 basis point increments.
Inflation Set To Slow Down
In the short term, the Bank revised its inflation expectations, with the “most likely” path predicting a fourth-quarter rate of 4.6%, a slight reduction from the 4.9% forecast in August. However, it raised its outlook for the fourth quarter of the following year to 3.1%, up from the previous 2.5%.
The return to below the 2% inflation target may occur in the fourth quarter of 2025, although the inflation projection for that period changed to 1.9% from the previous 1.6%.
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BOE forecasts for U.K. main economic indicators. Credit: BOE data.
“In the Monetary Policy Committee’s latest ‘most likely’ projection, considering the market-implied path for the bank rate, CPI inflation is projected to return to the 2% target by the end of 2025. Subsequently, it is expected to fall below the target, as increasing economic slack reduces domestic inflationary pressures,” the Bank of England said:
More recently, September’s data indicated that U.K. inflation remained unexpectedly resilient. The Office for National Statistics reported a 6.7% annual increase in consumer prices in September, matching the rate from August. This figure was higher than market forecasts, which had anticipated a cooling to 6.5% in September.
However, the September figure fell slightly below the BoE’s expectations, so the BoE revised its expectations for GDP growth.
It lowered the fourth-quarter GDP forecast to 0.6%, down from the previous outlook of 0.9%. The projection for a year later now suggests GDP will remain flat.
This compares to the previous forecast of a 0.1% rise. For the fourth quarter of 2025, forecasts see growth to be 0.4%, slightly reduced from the earlier 0.5% estimate.
A Historical Glimpse At U.K. Interest Rates
A review of the Bank of England’s interest rate history reveals a significant shift in approach beginning in February 2008. The global financial crisis prompted this shift, which originated in the U.S. with the housing market bubble in 2007 but subsequently impacted the U.K. economy.
Throughout 2008, the BoE implemented five rate cuts, reducing the rate from 5.25% in February to 2% in December. This 2% rate marked the lowest level since the banking crises of the 1880s and 1890s, as reported by the International Monetary Fund (IMF). It was also the lowest level since the Great Depression and World War II in the BoE’s interest rate history.
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U.K. interest rates increased notably after the pandemic ended. Source: BOE data.
In 2020, the BoE made two rapid interest rate cuts on March 11 and 19. These moves drove the U.K. interest rates to an unprecedented low of 0.1%. This sharp reduction mirrored the emergency measures other central banks and governments worldwide adopted to bolster their economies during the COVID-19 pandemic.
The Post-Pandemic Interest Rate Adjustment
The near-zero interest rate remained in effect until December 2021 , as the U.K. and other nations gradually reopened their economies. As the recovery gathered steam and inflation surged in tandem, the BoE increased the bank rate from 0.1% to 0.25% on Dec. 16, 2021.
This marked the U.K. as the world’s first leading economy to raise interest rates following the pandemic.
With the economy rebounding and commodity and energy prices soaring due to Russia’s invasion of Ukraine in February 2022, the BoE implemented eight rate hikes throughout 2022. By year-end, the bank rate had reached 3.5%.
In 2023, the U.K. Central Bank continued its tightening policy. It raised rates by 50 basis points (bps) to 4% in February. A 0.25% increase to 4.25% followed in March. And an additional 25 bps hike occurred in May, pushing the rate to 4.5%.
Post-Pandemic Pound Performance
The prospect of the Bank of England’s more aggressive approach to interest rates is the primary reason for the pound’s rally in April of this year. The markets are particularly attracted to the substantial coupon flows from British Gilts.
U.K.’s ten-year yields are among the highest in G10 countries compared to Italian BTPs. The interest rate differential (30 basis points on Italian BTPs) is thus driving the British currency to its 2023 highs. The Bank of England is watching wage growth closely.
Market expectations suggest three to four interest rate hikes, potentially reaching 5.75% by year-end. With wages already up 5.8% year-on-year in the first quarter of 2023, they might stabilize at 5.4% by year-end. The labor market shows no signs of slowing down, with unemployment still low at 3.8%.
Assessing the Peak of U.K. Inflation in 2022
Inflation is pivotal in shaping the U.K.’s key interest rate in the short to medium term.
In 2022, U.K. inflation accelerated, with the consumer price index (CPI) reaching 11.1% in October. Although it temporarily receded towards the end of the year, a surprise uptick to 10.4% in February occurred. Rising food and non-alcoholic drink costs have driven the increase. Subsequently, inflation eased to 10.1% in March.
Inflation, economic growth, and labor market conditions will shape the Bank of England’s interest rate decisions in the coming years.
U.K. Interest Rate Projections For the Next 5 Years
Given the substantial increase in the Bank Rate at the onset of this tightening cycle, the current monetary policy stance is restrictive. The outlook for GDP anticipates a period of relatively stagnant growth during the first half of the forecast period. Furthermore, growth will remain well below historical averages in the medium term. This is partly due to diminishing fiscal stimulus and subdued potential supply growth.
The BOE said, “Compared to our assessment in August, the GDP forecast has been revised downward to account for recent data indicating weaker-than-expected economic activity.”
Tcommitteetee also decided to reduce the magnitude of the previous demand-boosting judgment in this forecast. However, the BoE said it was not entirely out of discussion.
In recent quarters, excess demand in the U.K. economy has decreased. Now, analysts expect a gradual increase in economic slack from the beginning of the next year. Unemployment will rise throughout the forecast period. It may exceed the committee’s revised medium-term equilibrium estimate by the end of the year.
The Bank said, “Additionally, uncertainties have arisen concerning the ONS’s official labor market activity data, primarily based on the Labour Force Survey. Therefore, the committee continues to weigh insights from a variety of indicators.”
Following the latest U.K. main economic indicators, the BoE expects an interest rate of 5.3% by the end of 2023. It also expects a rate of 5.1% for 2024, 4.5% for 2025, and 4.2% for 2026.
Impact Of Interest Rates On Cryptocurrency
Cryptocurrencies, including Bitcoin (BTC), have exhibited remarkable resilience despite rising interest rates. Notably, Bitcoin saw impressive growth, surging by 2,000% during the years 2015 and 2016, when interest rates notably increased.
However, elevated interest rates can have various effects on the cryptocurrency market. Persistently high inflation, rising gas prices, and increased energy costs due to higher interest rates may dampen risk appetite. According to some experts, they also pose challenges for cryptocurrencies.
Central Banks Influence On Cryptocurrencies
Central Banks play a pivotal role in shaping economic conditions by directly impacting money circulation and financial market stability.
Their ability to adjust interest rates directly affects borrowing rates for financial and banking institutions. Major central banks like the Fed, ECB, and BoE have opted for interest rate hikes in response to widespread inflation.
It is worth noting the increasingly intertwined relationship between cryptocurrencies and these macroeconomic and monetary shifts. The decisions to increase interest rates, particularly by the Fed, have immediate consequences for the cryptocurrency markets.
In simpler terms, the Fed’s more assertive stance has cast uncertainty over cryptocurrencies. It influences market sentiment as tighter monetary policies have become necessary.
Most central banks have raised interest rates, with a few exceptions. Simultaneously, Bitcoin’s value declined over the past year, highlighting the interaction between central bank actions and cryptocurrency markets.
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