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Projected UK Interest Rates in 5 Years: Bank of England Cuts Rates but Warns on Inflation

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Giuseppe Ciccomascolo
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Key Takeaways
  • 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 favor 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%.

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 today 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 the analysts, “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.”

U.K. Economy Disappoints

According to data  from the Office for National Statistics (ONS), the U.K. economy grew in November but fell short of expectations.

Gross domestic product (GDP) rose by 0.1% in November, following a 0.1% contraction in October. As reported by FXStreet, this was below the analysts’ 0.2% growth forecast.

Growth was driven by the services sector, with “human health and social work activities” contributing the most to increased services output.

The ONS reported a 1.3% rise in this category during the three months to November 2024, compared to the three months to August.

Another key contributor was professional, scientific, and technical activities, where output rose by 0.6% in November.

However, real GDP remained flat compared to the previous three months until the end of November.

Stagflation Ahead

Michael Brown, Senior Research Strategist at Pepperstone, said, “The figures do nothing to change the narrative in the grand scheme of things, in that the U.K. continues to grapple with a grim macroeconomic backdrop, of largely stagnant economic growth, combined with stubborn price pressures.”

On top of this, after the recent sell-off across the Gilt curve, Chancellor Reeves’s fiscal headroom has been all-but-eroded, likely leading to further tax hikes and/or spending cuts as 2025 progresses, thus posing a further stiff growth headwind, according to Brown.

“Consequently, 2025 is likely to remain a year of stagflation for the U.K. economy, permitting the Bank of England to ease policy only gradually, likely continuing with the present quarterly pace of 25 basis points cuts with another such move at the February meeting,” Brown added.

For Brown, the BoE may be unable to lower rates to support growth as much as policymakers desire, owing to the sticky nature of underlying inflation within the U.K. economy.

Inflation Slows In December

Data released by the Office for National Statistics  showed that consumer price inflation in the U.K. eased more than anticipated in December.

The consumer price index increased by 2.5% in December compared to the same month the previous year, down from a 2.6% annual rise in November.

As cited by FXStreet , the market consensus had forecasted inflation to climb to 2.7%.

Month-on-month, consumer prices rose by 0.3% in December, accelerating from a 0.1% increase in November but falling short of the expected 0.4% rise.

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 said, 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.

Diverting BoE Path

Matthew Ryan, Head of Market Strategy at global financial services firm Ebury, agrees that surprising inflation figures will divert the Bank of England’s path.

“Chancellor Rachel Reeves will have breathed a sigh of relief when checking her inbox this morning, as U.K. inflation unexpectedly dropped in December, albeit to levels that are still comfortably above the 2% target,” Ryan said.

“In light of the nagging upside risks to consumer prices, we’ve seen a very muted reaction in the pound to the inflation report.”

“We don’t think that the data will change things too much for the Bank of England. The doves will argue that weak activity data and signs of a downtrend in inflation warrant immediate interest rate cuts.”

“Yet, the hawks will argue that they need more confidence that inflation is returning to target, particularly given uncertainties surrounding the new fiscal plans and Trump’s tariffs.”

GDP Revised Flat

According to revised data from the Office for National Statistics (ONS)  released on Monday, the U.K. economy experienced zero growth in the third quarter.

In the three months ending Sept. 30, real GDP remained flat compared to the previous quarter. This is a downgrade from the initial estimate of 0.1% growth. On an annual basis, GDP rose by 0.9% compared to the same period last year.

The ONS noted that the overall quarterly GDP trajectory remains consistent with the Q1 2023 to Q1 2024 trend. However, revisions lowered growth estimates by 0.1 percentage points for the second and third quarters of 2024.

“Preliminary data indicates that real GDP per capita declined by 0.2% in Q3 2024, leaving it 0.2% lower than a year earlier,” the ONS reported.

Sector-specific data revealed no growth in services during the quarter. A 0.7% rise in construction output was counterbalanced by a 0.4% decline in the production sector, underscoring the industry’s uneven performance.

U.K. Consumer “Spending Squeeze”

The British Retail Consortium (BRC) cautioned on Monday 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.

More Cuts On The Horizon

Looking ahead, the BoE indicated  that a “gradual” approach to easing policy restrictions remains appropriate, citing “significant uncertainty” surrounding the labor market and various possible inflation scenarios.

“We need to ensure inflation remains low, so we won’t reduce interest rates too quickly or by too much,” the BoE stated .

“If conditions unfold as anticipated, interest rates are likely to decline gradually.”

Bank of England cut interest rates
Bank of England cut interest rates again in November. | Credit: BoE

This decision follows last week’s budget announcement and the election of Donald Trump as U.S. president, both of which are expected to exert upward pressure on inflation.

The BoE noted that, compared to August forecasts, the budget is expected to raise GDP by around 75 basis points at its peak within a year, with an inflation impact of just under 50 basis points.

Bailey Open to ‘More Aggressive’ Cuts

In an interview with the Guardian , Bank of England Governor Andrew Bailey suggested that the central bank may become more aggressive in cutting interest rates if inflation declines.

The governor emphasized that the U.K. economy has proven more resilient than initially feared, weathering the shocks of the past few years. This resilience provides a solid foundation for further monetary policy adjustments.

Bailey’s comments suggest that the BoE closely monitors inflation data and will take more decisive action to support economic growth if necessary.

“The government is right to focus on how to encourage capital investment. There is a clear need for it in terms of infrastructure. We’ve got at least three very big structural issues out there.”

“One is the aging population, which, obviously, we’re not alone in that one. Two is the demand for an increase in defense spending. And the third one is dealing with climate change.”

U.K. inflation expectations still support a cautious BOE easing approach. In line with consensus, the BOE Decision Maker Panel survey (DMP) 1-year inflation expectations rose one tick to 2.7% in September. But remained near the lows since this series began in 2022.

In September, 3-year inflation expectations stood at 2.7% for the second consecutive month, remaining within the same narrow range throughout the year.

Goldman’s Expectations for the U.K. Economy

One of the primary reasons for Goldman Sachs’ revised outlook is the expectation of a notable 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%.

BoE forecasts for UK main economic indicators
Credit: Bank of England

The Bank of England said:

“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.”

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.

Introducing the Bank of England (BoE)

The Bank of England is the central bank of the United Kingdom, with a history dating back to 1694. It is the second-oldest central bank globally, following Sweden’s Sveriges Riksbank.

Initially founded as a private bank to serve the government’s financial needs, the BoE received a royal charter from King William and Queen Mary in 1694. At that time, its primary mission was to raise £1.2 million in loans to finance the war against France.

Surprisingly, over 1,200 individuals from diverse backgrounds, including carpenters, grocers, merchants, doctors, knights, and even royalty, bought the bank’s shares, making them its inaugural shareholders. Notably, King William and Queen Mary themselves held shares in the bank.

As a central bank, the BoE’s primary objective is to maintain price stability by targeting an inflation rate of 2%. To achieve this, the BoE adjusts its key interest rate to manage inflation.

The nine-member Monetary Policy Committee determines the bank rate. It includes the governor’s three deputy governors overseeing monetary policy, financial stability, markets, and banking.

Additionally, there is a chief economist and four external members. They are appointed directly by the Chancellor of the Exchequer, the second most significant cabinet member after the Prime Minister. MPC members serve fixed terms and can be replaced or reappointed. The committee meets eight times yearly, approximately every six weeks, to decide on monetary policy actions.

In addition to monetary policy, the BoE oversees banknote production and payment services and regulates financial institutions. It also manages the U.K.’s gold reserves, holding about 400,000 gold bars in an impressive vault.

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.

UK interest rates over the years
U.K. interest rates increased notably after the pandemic ended.

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.

Sterling performance
The U.K. pound didn’t collapse as feared after the pandemic and Brexit

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 notably 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.

The 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 and Their 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, influencing 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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Giuseppe Ciccomascolo

Giuseppe Ciccomascolo began his career as an investigative journalist in Italy, where he contributed to both local and national newspapers, focusing on various financial sectors. Upon relocating to London, he worked as an analyst for Fitch's CapitalStructure and later as a Senior Reporter for Alliance News. In 2017, Giuseppe transitioned to covering cryptocurrency-related news, producing documentaries and articles on Bitcoin and other emerging digital currencies. He also played a pivotal role in establishing the academy for a cryptocurrency exchange website. Crypto remained his primary area of interest throughout his tenure as a writer for ThirdFloor.
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