Bank of England to resume rate cuts with outlook complicated by tax hikes and Trump tariffs

The Bank of England is widely expected to cut interest rates on Thursday, amid a complex backdrop of a tepid domestic growth outlook, an upcoming hike in taxes paid by businesses and U.S. President Donald Trump’s market-rattling tariff threats.

As of Wednesday morning, Money markets were pricing in a 98% probability of a quarter-point rate cut at the February meeting, which would take the Bank rate to 4.5%. The BOE opted to hold at its previous gathering in December, citing “elevated” services inflation of 5% and a higher-than-expected headline print of 2.6% in November. That rate has since cooled to 2.5%, while services inflation dropped to a 33-month low of 4.4%.

Since January, traders have ramped up their bets on the total number of BOE rate cuts likely to take place during 2025. Where at the start of the year only two trims were expected, economists and prominent business voices including the head of British bank Lloyds, Charlie Nunn, have said they anticipate three trims. Markets are meanwhile pricing more than 80 basis points’ worth of cuts by December, suggesting four reductions could be a possibility.

Those bets have built on the back of several data surprises, including weaker-than-expected retail sales data and disappointing November growth.

Closely watched on Thursday will be the vote split among the nine members of the Monetary Policy Committee — with a unanimous or near-unanimous decision suggesting a bias toward easing — as well as the BOE’s updated growth and inflation projections.

The U.K. economy stagnated in the third quarter, and the BOE has already forecast that the final three months of last year also showed no growth.

Any downgrade to the BOE’s 2025 growth projections, or to its outlook for inflation to hit 2.7% in the fourth quarter of 2025 and ease to 2.2% across 2026, will be seen as support for the doves.

The first is how the central bank now views any potential inflationary impact from the fiscal reforms announced by the U.K. government in October, which include a significant hike in the tax that businesses face on payrolls. A survey by the British Chambers of Commerce published January said some firms were planning price rises as a result of higher costs.

The second question is how the U.K. will fare amid Trump’s volatile trade policy and the start of his tit-for-tat trade war with China, which is currently tamer than originally feared. Trump has threatened to slap tariffs on imports from the U.K. and European Union, but his delay of duties on Canada and Mexico has suggested other countries may be able to negotiate their way out of the fight.

It has also been suggested that the U.K. could benefit from wider trade disputes with the U.S. due to its more balanced trade relationship with the world’s biggest economy, allowing for an increase in U.K. investment and new trade opportunities.

“If Chinese goods find their way to the continent and into the U.K., and exert a downward pressure on prices, it gives the [European Central Bank] and the BOE more scope to lower interest rates more aggressively than markets are anticipating this year, especially as growth is expected to weaken over the coming quarters,” Dan Boardman-Weston, chief executive officer and chief investment officer of BRI Wealth Management, told CNBC’s “Street Signs” on Tuesday.

That is likely to reaffirm the monetary policy divergence between the BOE and the ECB — which markets view as likely to cut by a whole percentage point this year — and the U.S. Federal Reserve, seen trimming by a half-point at most.

Anthony Karaminas, global head of sub-advised fixed income at SEI, said that the U.K.’s situation of “stagflation-lite” — economic stagnation combined with above-target inflation — was a challenge for the BOE as it “seeks to support economic activity while also adhering to its explicit inflation mandate.”

“Looking ahead, sticky inflation might limit Governor Bailey’s ability to cut rates much further,” Karaminas said in emailed comments.

It the central bank presses ahead with a swift pace of easing, the U.K. government bond market “could suffer a credibility penalty in the form of a significantly higher term premium,” he said, adding this would limit the scope of the government to spend to boost the economy at a time when it “desperately needs a dose of productivity-driven growth.”

U.K. borrowing costs spiked in January amid a global bond market sell-off and stoked by concerns about Britain’s deficit and weak growth forecasts. Borrowing costs have since fallen significantly.