Bank cuts rates, but is inflation on a U-shaped trajectory? AJ Bell analysis

Laith Khalaf, Head of Investment Analysis at AJ Bell, says the Bank of England’s Christmas rate cut offers welcome relief for households and businesses, but warns the Monetary Policy Committee’s minutes strike a distinctly cautious, hawkish tone amid ongoing concerns over inflation and wages.

Laith Khalaf, head of investment analysis at AJ Bell, comments on the latest interest rate decision from the Bank of England:

“A Christmas rate cut will bring some much needed financial cheer to households and businesses across the country, especially those who are battling to keep the show on the road. But there were definite signs of hawkishness in the minutes of the MPC meeting.

“Inflation is now expected to fall back closer to the 2% target in the spring, which would be a real boost to consumers. The Bank reckons this is largely down to the energy price measures included in Rachel Reeves’ recent Budget, so credit where it’s due.

“But this has failed to significantly move the dial for some members of the rate setting committee. The vote to cut rates was still close, with four members wanting to hold rates at 4%, even though inflation is expected to return close to target within a few months.

“That suggests they may be worried about a U-shaped trajectory for CPI, settling at a rate above 2% in the medium term. Indeed, even though the effects of the Budget are disinflationary in the short term, they are expected to push inflation up a touch in 2027 and 2028. It seems clear that wage inflation is a major concern for the hawks in the Bank of England, so that is a key metric to watch going forward for an indication of where monetary policy might be heading.

“The Bank says any further loosening will still be gradual, allowing them to assess incoming data, noting we are now getting nearer to the estimated neutral rate, which limits the scope for further rate cuts. Indeed, it sounds like some members of the committee already think we have reached the neutral rate, and that monetary policy is no longer that restrictive. The minutes also mentioned a high bar for policy reversals – in other words, the Bank doesn’t want to cut too far only to have to hike again. 

“All in all, the rhetoric and tone of committee’s minutes look pitched at restraining animal spirits. Despite the rate cut, the Bank remains in cautious mode, wary of both persistent inflation and policy errors.”