Bank of England holds rates at 3.75% in knife-edge vote, signals cuts likely ahead

The Bank of England left interest rates unchanged on Thursday in one of its closest calls since gaining independence, holding Bank Rate at 3.75% but signaling that borrowing costs are likely to fall further in the coming months as inflation moves back toward target and the economy slows.

Knife-edge decision shifts market expectations

The Monetary Policy Committee voted 5–4 to keep the benchmark rate steady, with four members backing a quarter-point cut to 3.5%. The narrow split—far closer than most economists had expected—pushed down government bond yields and weakened the pound as investors brought forward bets on when rate cuts will resume.

In its Monetary Policy Summary, the central bank said that “on the basis of the current evidence, Bank Rate is likely to be reduced further,” and that decisions on additional easing would become a “closer call.” The language marked a clear softening from last year’s emphasis on keeping rates “higher for longer” to squeeze out inflation.

Governor Andrew Bailey said the Bank now expects the annual inflation rate to fall back “to around 2% by the spring,” adding there should be “scope for some further reduction in Bank Rate this year” if incoming data on prices, wages and activity evolve as projected.

“I will go into the coming meetings asking whether a cut is justified,” Bailey told reporters in London.

In a separate television interview, he said market pricing that puts roughly 50–50 odds on a rate cut at the next meeting in March was “not a bad place to be.”

The decision followed a meeting that ended Feb. 4, alongside the publication of the Bank’s latest Monetary Policy Report, which revised down growth forecasts and brought forward the expected date when inflation returns to the 2% target.

Inflation forecast improves, helped by energy policy

Headline consumer price inflation stood at 3.4% in December, down from 3.8% in September but still above target. The Bank now projects that inflation will drop to a little above 2% in the second quarter of 2026, around a year earlier than it anticipated in November.

Officials said the faster disinflation is driven largely by lower energy bills stemming from government policy, as well as the unwinding of earlier spikes in regulated prices and taxes.

Chancellor Rachel Reeves’ 2025 Budget included measures set to remove about £150 from the average annual household energy bill from April by shifting some environmental and social levies into general taxation. Energy regulator Ofgem is expected to cut its price cap from £1,758 to £1,616, a change the Bank said would make a significant contribution to lower measured inflation this year.

Growth outlook weakens and labor market loosens

At the same time, the Bank’s forecasts point to a weaker economy and a looser labor market than previously expected. Unemployment has edged up to just above 5% and is projected to peak at around 5.3% later this year.

Private-sector regular pay growth has slowed to about 3.6% on a three-month annualized basis and is forecast to ease further toward the low 3% range over 2026.

Gross domestic product is estimated to have grown by only 0.1% in the final quarter of 2025, down from 0.2% in the previous quarter and below the Bank’s estimate of the economy’s potential growth rate. The new report cuts the forecast for 2026 growth to about 0.9%, from around 1.2% previously, and suggests the economy is operating with increasing spare capacity, with the output gap put at roughly minus 1% of GDP.

That mix of faster-than-expected disinflation and fragile growth underpinned the sharp split on the nine-member MPC.

Split committee: persistence risks vs. demand risks

Bailey, Deputy Governor Clare Lombardelli, external members Megan Greene and Catherine Mann, and Chief Economist Huw Pill voted to hold rates. While some acknowledged that the risks of entrenched inflation pressures have diminished, they argued that it was still too soon to declare victory over price and wage dynamics.

Those members “put more weight on risks from inflation persistence,” the minutes said, warning that wage and price-setting behavior could remain too strong once headline inflation falls—especially with weak productivity and uncertainty about how much slack there really is in the economy.

The four-member minority—Deputy Governors Sarah Breeden and Dave Ramsden, and externals Swati Dhingra and Alan Taylor—backed an immediate 0.25 percentage point cut. They judged that the risk of persistent inflation had “receded materially” and stressed growing dangers from weak demand, rising unemployment and elevated household savings.

“For these members, policy remained too restrictive and risked an unnecessarily prolonged period of below-potential growth,” the minutes said.

Markets reprice; global central banks hold steady

The close vote surprised many analysts. Money markets that before the meeting had priced only a small chance of a cut in March shifted to a coin-toss probability and to roughly 50 to 75 basis points of easing over the course of 2026.

Benchmark gilt yields fell as traders bought government bonds, while sterling slipped against major currencies. The pound’s decline reflected the relatively more dovish tone from the Bank of England compared with the U.S. Federal Reserve and the European Central Bank.

The Fed left its target range for the federal funds rate at 3.5% to 3.75% at its late January meeting and has signaled a cautious, meeting-by-meeting approach to any further reductions after cutting rates three times in late 2025. Chair Jerome Powell recently said it was “hard to look at the data and say that policy is significantly restrictive right now,” a sign investors took to mean the Fed is in no rush to ease.

The ECB on Thursday also kept its key policy rates unchanged, including a deposit rate of around 2%, reiterating that inflation is expected to stabilize at 2% in the medium term without signaling imminent additional cuts.

By contrast, the Bank of England has already lowered Bank Rate by 1.5 percentage points from a peak of 5.25% in August 2024 and is now openly preparing the ground for more easing, even as it stresses decisions remain contingent on the data.

What it means for households, mortgages, and the Budget

The domestic policy backdrop is adding complexity. While the Budget’s energy measures and other cost-of-living policies are helping to push inflation lower in the near term, the same fiscal plan envisages tighter public finances over the medium term. The Bank estimates that will weigh on demand and keep the economy operating below capacity for several years.

The rate path has direct consequences for households and businesses. The Bank estimates that about 1.8 million fixed-rate mortgages will reset this year as deals agreed when interest rates were near zero during the pandemic era expire. Lenders had nudged mortgage rates higher in recent weeks on the assumption that rate cuts might come more slowly; Thursday’s guidance is expected to cap—or perhaps gently reverse—that trend, though borrowing costs remain well above pre-pandemic levels.

Trade unions and some business groups urged the Bank to move faster. The Trades Union Congress said that with inflation close to target and real wages still recovering from the price surge, the MPC should embark on a “rapid-fire sequence of rate cuts” to protect jobs and living standards. The Bank did not respond directly, reiterating its legal mandate to deliver 2% inflation sustainably.

Bailey addresses institutional trust amid unrelated revelations

Bailey also used part of his press conference to address broader questions of trust in economic institutions. Asked about recently disclosed dealings between former minister Peter Mandelson and the late financier Jeffrey Epstein during the 2008–09 financial crisis, he said he was “shocked” by the revelations and praised former Chancellor Alistair Darling’s conduct during that period.

Looking ahead

For now, the Bank’s message is that the emergency phase of the inflation shock is over, but the exit from tight policy will be gradual and contested. Upcoming data on inflation, wages and output—along with the balance of arguments on a deeply divided committee—will determine whether Thursday’s knife-edge hold proves to be the last pause before cuts resume or the start of a more extended wait.