By William Schomberg, David Milliken and Andy Bruce
LONDON, Feb 5 (Reuters) – The Bank of England kept interest rates on hold on Thursday, but only after an unexpectedly narrow 5-4 vote, and said borrowing costs are likely to fall if an expected drop soon in inflation is sustained.
Despite a big cut to its economic growth forecast this year along with a rise in unemployment, the BoE left its benchmark rate at 3.75%, as expected in a Reuters poll of economists.
However, the poll had pointed to a 7-2 vote.
Sterling slid by almost a cent against the U.S. dollar – and was heading for its biggest one-day fall since September – as investors priced in an earlier rate cut by the BoE.
Two-year government bond yields fell by about seven basis points to touch their lowest since January 14 at 3.620% before recovering some of their drop.
“Cooling demand, fading inflation risks and a softening labour market all support the case for easing. If not March, then April remains the most plausible window for the next cut,” said Stefan Koopman, senior macro strategist at Rabobank.
The chance of a rate cut in March was being priced at close to 50% – something Governor Andrew Bailey said looked reasonable – up from around 25% before Thursday’s announcement.
BAILEY SEES SCOPE FOR FURTHER REDUCTION IN RATES
Bailey, one of the five Monetary Policy Committee members who backed the decision to hold, said his main message was one of “good news” with inflation seemingly losing momentum more quickly than the BoE thought three months ago.
“All going well, there should be scope for some further reduction in Bank Rate this year,” he said.
Bailey stressed he did not have any specific date in mind for the next rate cut but described market expectations for two quarter-point reductions this year as “reasonable”.
He was asked by reporters about recent bond market moves, with investors assessing whether Prime Minister Keir Starmer can survive the fallout from naming Peter Mandelson as U.S. ambassador despite knowing about his ties to Jeffrey Epstein.
Bailey said a rise in yields – seen on Wednesday and earlier on Thursday – had been orderly. Deputy Governor Dave Ramsden said they were much smaller than during the volatility sparked by U.S. President Donald Trump’s trade tariff announcements.
The BoE has been moving cautiously as Britain has the highest inflation rate among the world’s big, rich economies.
It cut rates four times in 2025 including a quarter-point reduction in December which was backed by a 5-4 vote.
But policymakers have turned more cautious as they approach the level of borrowing costs that is neither inflationary nor a drag on an economy still struggling to recover from Brexit, the COVID pandemic and the 2022 surge in energy prices.
The European Central Bank kept its benchmark borrowing rate at 2% – almost half that of the BoE – on Thursday.
The BoE forecast inflation would slide to around its 2% target in April, helped largely by finance minister Rachel Reeves’ budget in November.
But the central bank stressed it wanted to make sure the fall was not a one-off.
Staff forecasts showed inflation dropping below its target to 1.7% before hovering around its 2% target from the second quarter of 2027 until the end of its three-year forecast period.
MPC SPLIT ON INFLATION RISKS
Three of the five MPC members who backed no cut this week – chief economist Huw Pill, deputy governor Clare Lombardelli and external member Megan Greene – said inflation pressure was easing but they favoured “a more prolonged period of policy restriction.”
Bailey and external member Catherine Mann said evidence to support a further cut was increasing, but not yet sufficient.
The four who backed a cut – deputy governors Dave Ramsden and Sarah Breeden plus Swati Dhingra and Alan Taylor – were more worried about inflation falling too low as the economy weakens.
The BoE cut its forecast for economic growth for 2026 to 0.9% from a previous estimate of 1.2% before a pickup in 2027 and 2028. It also raised its forecast for the peak in unemployment to 5.3%, up from 5.1% previously.
Despite the slowing economy, private-sector regular wage growth is likely to weaken only slowly this year, dropping to an annual rate of 3.3% by the end of 2026 from 3.4% in late 2025.
The BoE said a roughly 3.25% rate of pay growth was consistent with on-target inflation.
A BoE survey showed companies expected pay settlements of 3.4% this year, down from 4% in 2025.
The MPC left its guidance about the outlook for interest rates largely similar to its previous message in December.
“On the basis of the current evidence, Bank Rate is likely to be reduced further,” it said.
“Judgements around further policy easing will become a closer call. The extent and timing of further easing in monetary policy will depend on the evolution of the outlook for inflation.”
(Additional reporting by UK bureau; writing by William Schomberg; graphics by Sumanta Sen; Editing by Catherine Evans and Toby Chopra)
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