UK QUARTERLY ECONOMIC OUTLOOK | Q1 2025
Interest rates
Rising headline inflation won’t stop more interest rate cuts
Despite inflation rising over the first half of the year, it won’t stop the Bank of England (BoE) from cutting interest rates throughout the year. After a cut in February, we expect the MPC to opt for three more 25 basis points (bps) cuts in 2025. However, the nightmarish combination of weak growth and above target inflation will ensure the MPC remains on its “careful and gradual” rate cutting path.
Cutting interest rates when inflation is rising may seem unusual, but there are three good reasons why the MPC may keep more rate reductions coming. First, the BoE will probably view most of the coming increase in inflation as one-off increases to the price level rather than factors that will continue to put upward pressure on prices. Inflation is really being driven by a combination of higher energy prices and firms’ reactions to the autumn budget, which should drop out of inflation early next year. Our prediction is for inflation to return to 2% by mid-2026.
Second, services inflation, which is more reflective of domestically generated price pressures, should stabilise over the rest of the year and gradually begin to trend down in the autumn.
Third, the economy has clearly weakened recently and growth is likely to be much slower this year than previously thought. That will lessen the upward pressure on prices as firms struggle to pass on cost rises.
Admittedly, there are plenty of reasons for the MPC to be nervous
At 6%, wage growth is far too high for comfort and there is every chance that tariffs result in a significant increase in import costs at some point this year. What’s more, the labour market has held up better than expected despite increasing employment costs. This could mean pay growth remains far stickier than we expect, feeding into higher inflation as consumers start to spend increases in income. That will keep the MPC on its “careful and gradual” path.
Ultimately, we expect the MPC to cut rates by 25 bps at every other meeting this year, which would leave rates at 3.75% at the end of the year. The risks are broadly balanced. Stronger-than-expected wage growth would limit the number of rate cuts, but if growth continues to dramatically underperform, then further cuts are not out of the question.
We expect the base rate will settle between 3-3.5% in the long run.
Expectations for Interest Rates
