Bank of England readies rate cut and could hint at more to come

By Andy Bruce

(Reuters) - The Bank of England looks likely to cut interest rates next week, when it could also nudge investors to expect faster reductions than they currently predict as the economy flatlines.

Economists polled by Reuters unanimously expect the BoE to cut its benchmark rate to 4.5%, from 4.75%, on Feb. 6, when it will also update its economic growth and inflation forecasts. Investors see a nearly 90% chance of a cut next week.

Since the BoE published its last projections in November, the economy has stagnated and measures of inflation most closely watched by rate-setters dropped last month - although wage growth unexpectedly accelerated.

With the data offering mixed signals on the outlook, investors will be sensitive to any changes in the views of Monetary Policy Committee members. In December, six voted to keep rates on hold while three backed a quarter-point cut.

Rate-setters could give an early steer on a key question for the inflation outlook: how will employers respond to the government's Oct. 30 budget, which imposed a large hike in payroll taxes from April.

Financial markets on Wednesday priced in almost three quarter-point BoE rate cuts this year, compared with fewer than two in early January, when there was a sharp but short-lived surge in British government bond yields.

SHIFTING US RATE EXPECTATIONS

Driven by shifting U.S. rate expectations ahead of President Donald Trump's inauguration and unease around Britain's public finances, the sell-off forced finance minister Rachel Reeves to say she would act to meet her fiscal rules if needed.

She is probably hoping for a dovish turn by the BoE. The rise in government borrowing costs since the budget risks knocking her off course to meet the fiscal rules, potentially requiring tax hikes or spending cuts to get her back on track.

Expectations for BoE rate cuts priced by markets may be too incremental for the MPC's liking, with some members likely to emphasise risks from a weak economy, as well as a worsening outlook in the euro zone.

The European Central Bank has already reduced rates four times since mid-2024 - compared with twice for the BoE - and looks all but certain to deliver a fifth cut on Thursday.

"Although a dovish statement from the BoE can be expected to keep the pound on the back foot in the near-term, it would also provide comfort for investors and the business community," said Jane Foley, senior FX strategist at Rabobank.

Public comments by MPC members have been thin on the ground since the start of the year. Those who have offered views have tended to stress the potential for lower interest rates.

In his first speech since joining the MPC, external member Alan Taylor said on Jan. 15 it was time to cut rates and he expected to see four such moves in 2025.

TIMING OF CUTS

Deputy Governor Sarah Breeden said on Jan. 9 that economic data supported the BoE's message of gradual cuts, but it was hard to be sure of the timing.

While short-term market interest rates have fallen over the last couple of weeks, they remain sharply higher at the two- and three-year horizons compared with the rates that underpinned the BoE's November forecasts.

That means MPC members may judge that the financial conditions that influence corporate and mortgage borrowing rates are too tight, pushing inflation further below target in the coming years.

Philip Shaw, chief economist at Investec, said weak economic growth meant companies would find it harder to push the cost of tax hikes on to consumers.

"That should make it easier for the Bank of England to look through a near-term rise in inflation and deliver more rate cuts than currently priced in," Shaw said.

A business survey this week showed workers were likely to bear the brunt via slower wage increases.

(Reporting by Andy Bruce; Editing by Alex Richardson)