Inflation-Wary Bank of England Set to Keep Rates on Hold

Bank of England Likely to Maintain Interest Rates Amid Inflation Concerns

Bank of England's Interest Rate Decision

By William Schomberg

Current Economic Climate

LONDON, Feb 2 (Reuters) - British interest rates are likely to fall further this year but the Bank of England will probably sound vague this week about when or by how much it will cut borrowing costs as it awaits a clearer picture on inflation.

Market Expectations

The BoE is expected to keep its benchmark rate at 3.75% on Thursday, with Governor Andrew Bailey and colleagues keeping their options open.

Future Projections

Britain has the highest official borrowing costs among the world's big, rich economies, despite six rate cuts since mid-2024.

Further reductions might help Prime Minister Keir Starmer and finance minister Rachel Reeves to galvanise a sluggish economy.

However, December's inflation reading of 3.4% was also the highest in the Group of Seven leading industrialised nations. It looks set to slow to the BoE's 2% target soon but some policymakers fear underlying price pressures remain too strong.

"We expect Bank Rate to be cut twice this year. The timing of those rate cuts, however, is coming increasingly into question," Deutsche Bank Chief UK Economist Sanjay Raja said, adding that his forecast for cuts in March and June could be pushed back.

MARKETS DIAL BACK RATE CUT BETS

Investors are pricing almost no chance of a cut after this week's Monetary Policy Committee meeting and see less than a 50% chance of more than one rate cut this year. In mid-January, two quarter-point cuts were almost fully priced in.

That was before some tentative signs of momentum in Britain's economy and a scaling back of expectations for rate cuts in the United States, which influence UK markets.

Economists also expect little change to the BoE's latest economic forecasts, which in November pointed to inflation hovering around 2% in two and three years' time.

Bailey said last month - as U.S. President Donald Trump spoke of a trade war with Europe over Greenland - that the BoE was "very alert" to geopolitical risks, but market reaction has thus far been muted. Trump has since dropped his threats.

The main focus of investors at the BoE's policy announcement at 1200 GMT on Thursday - and a press conference half an hour later - is likely to be on any changes to its messaging.

In December, the MPC said rates were "likely to continue on a gradual downward path" but - with policymakers uncertain about how many cuts could prove to be too many - it added "judgements around further policy easing will become a closer call".

Some MPC members fear a slowdown in the strong pace of pay growth might peter out despite a recent rise in unemployment.

They will receive an annual BoE pay survey. MPC member Megan Greene said last month she was worried about preliminary data from the survey suggesting settlements of around 3.5% for 2026, above the roughly 3% level consistent with 2% inflation.

7-2 VOTE FOR HOLD SEEN IN REUTERS POLL

The MPC voted 5-4 to cut Bank Rate in December, the fourth quarter-point reduction of 2025. But most of its members suggested the pace of rate cuts could slow.

Some tentative signs of a recovery among consumers and businesses, after months of speculation about tax hikes in Reeves' November 26 budget, could add to the case for slow rate cuts.

Most economists polled by Reuters forecast a 7-2 MPC vote for no change in rates this week.

Economists at Barclays said the next cut would be in March after which the BoE would hold Bank Rate at 3.5% "given the caution on the committee that rates at that level may no longer be restrictive".

But Paul Dales, chief UK economist at Capital Economics, said inflation would probably slow more than expected, allowing the BoE to cut rates three times in 2026 starting in April.

(Writing by William SchombergEditing by Gareth Jones)