Bank of England set to cut rates as inflation and economy slow

By William Schomberg

LONDON, ‌Dec 18 (Reuters) - The Bank of England is expected to lower interest rates on Thursday after a sharp slowdown in inflation and a weakening ‍in economic ‌growth, but a string of further cuts in 2026 looks unlikely given Britain's lingering price pressures.

Investors think the BoE will reduce its benchmark rate to ⁠3.75% from 4% for a fourth cut of 2025, welcome news for ‌finance minister Rachel Reeves and Prime Minister Keir Starmer who are struggling to meet promises to voters of faster economic growth.

A quarter-point cut would take Bank Rate to its lowest level in nearly three years, although that would still be almost double the equivalent rate of the European Central Bank.

British inflation remains the highest among the Group of Seven ⁠economies - in part because of Reeves' decision last year to raise taxes on employers - even after it fell sharply to 3.2% in data released on Wednesday.

Investors are fully pricing only one more BoE ​rate cut in 2026, most likely by the end of April, although bets on a ‌second one rose after the November inflation drop.

ENTRENCHED POSITIONS ON MONETARY POLICY ⁠COMMITTEE

Hetal Mehta, chief economist at wealth management firm St. James's Place, said the different camps on the BoE's Monetary Policy Committee were unlikely to shift their medium-term stances significantly this week.

"There's enough ambiguity around some of the numbers going into next year for there not to be back-to-back rate ​cuts," Mehta said. "The data confirms the direction of travel. It's the magnitude (of rate cuts) that is up for debate."

The nine members of the Monetary Policy Committee have been almost evenly split in recent months. In November they voted 5-4 to keep rates on hold.

Analysts polled by Reuters last week forecast a 5-4 split in favour of a cut at their December meeting with Governor Andrew Bailey switching sides to tip the balance.

Wednesday's bigger-than-expected inflation slowdown - which followed ​data on ‍Tuesday showing a weakening jobs market including the ​highest unemployment rate since 2021 - might now persuade more MPC members to vote for a cut, Mehta said.

Britain's economy shrank 0.1% in the three months to October amid reports that businesses put investment projects on ice in the run-up to Reeves' budget on November 26.

INFLATION PRESSURES PERSIST IN UK

But Britain is not out of its inflation problem yet.

S&P Global's Purchasing Managers' Index, also published on Tuesday, showed rising inflation pressures and suggested businesses were turning a corner after the budget.

Relief at the BoE over the big drop in the headline inflation rate is likely to be tempered by only a small fall in the pace of ⁠price increases in the services sector.

Furthermore, the inflation-reducing impact of Reeves' budget - which removed green levies from power bills and froze rail fares - is likely to be only temporary.

Other major central banks are believed to be close to ​halting their rate cuts - the U.S. Federal Reserve last week signalled one more in 2026 while the ECB has probably already come to the end of its monetary loosening cycle.

Economists are watching closely for any change in the BoE's language in Thursday's statement about the prospect of further reductions, including possible changes to its recent description of borrowing costs as being on a "gradual downward path".

"Because inflation remains above target ‌and services components still look sticky, policymakers are unlikely to deliver a deeply dovish message," Daniela Hathorn, senior market analyst at trading platform Capital.com, said.

"Instead, the BoE is likely to frame any cut as part of a gradual, risk-managed shift rather than a full easing cycle."

(Writing by William Schomberg; Editing by Catherine Evans)