The latest data from the Office for National Statistics shows UK inflation easing slightly to 3.4% in May, down from 3.5% in April (or 3.4% given the ONS’s error), thanks largely to weaker transport costs, but still well above the Bank of England’s 2% target. Core CPI, which excludes volatile items like food and energy, sits at 3.5%, while services inflation moderated from 5.4% to 4.7%. Despite this slowdown, food and household goods inflation picked up in May, underlining the mixed nature of price pressures. While there was some encouraging news in the data, the Bank of England (BoE) is unlikely to alter its current cautious monetary easing policy.
For the UK, last week’s aggressive policy move by the Swiss National Bank would be unthinkable. The SNB slashed its rate to 0% to combat deflation, after Swiss CPI came in at -0.1% for May. It highlights a growing theme in global monetary policy - central banks are increasingly willing to pivot if inflation cools. Switzerland now stands at the most dovish end of the spectrum, but the European Central Bank has already taken the deposit rate to 2%, the Riksbank in Sweden also has its policy rate at 2% and the Bank of Canada now has a policy rate of 2.75%.
Yet despite the downward global drift, no one in the UK, including markets, analysts, or seemingly most MPC members, is currently forecasting a return to much lower or near-zero interest rates.
Commentary from economists, including HM Treasury, Reuters and Bloomberg polls, suggests that while the market expects the Bank of England to begin cutting rates, there’s no anticipation of rates falling anywhere near zero. Current market pricing suggests Bank Rate will ease to around 3.75% by year-end, and a developing consensus that Bank Rate may fall to 3.5% by early 2026. Some envisage a steady trimming of 25 bp increments through 2025 and into 2026, taking Bank Rate closer to 3%, but still higher than some of these other examples.
The BoE’s Monetary Policy Committee, appears to agree. There have been consistent voices on the MPC calling for faster rate cuts, emphasising that much of today's inflation stems from regulated or government-administered prices, utilities, energy bills, taxes, which are inherently temporary. The majority, though, is clearly anxious about stimulating economic activity in an environment that may quickly stoke renewed inflationary pressure, led by a looser but still tight labour market and low productivity growth.
However, looking at the broader context of UK economic data, the case for further on-going rate cuts strengthens. Growth is sluggish, with underlying GDP lacking momentum even if headline figures have been lifted by one off factors like pre-tariff buying. Business investment remains weak, and geopolitical uncertainty is dampening confidence and global trade. The labour market, once resilient, has softened: the S&P Global PMI reports consecutive months of falling employment, vacancies are down, and recent ONS figures show the largest payroll decline in five years. Wages, while still elevated, are decelerating, and inflation expectations have fallen. Households are saving rather than spending. Government spending is likely to be the main driver of economic growth over the next year or so.
This is a familiar set of conditions, a slowing economy, cooling labour market, and selective inflation, yet few see a likelihood of much lower interest rates for the UK. For the UK to truly approach that territory, it seems we need policymakers to see a convergence of factors: inflation must be sustainably at 2%, wage growth must continue to slow, the economy likely further stagnate or contract, and global central banks, particularly the Fed, would need to move decisively into easing mode (which seems less likely in the short term given the US administration’s tariff policy). The risk, of course, is that these factors are only apparent after rates should have been much lower, depressing activity and investment for longer than necessary.
Much lower rates cannot be discounted and the SNB’s action highlights that even zero rates have made a comeback. For some countries, it may also suggest that talk of a new post-pandemic economic paradigm may have been misplaced. This may not be the path followed by the UK economy given our productivity issues (we’ll have to see what AI brings to the table here), but it shows that pre-pandemic issues of low growth and low interest rates may not be entirely a thing of the past.
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