UK inflation in June fell to a 15-month low, while private sector wage growth dropped to its weakest level since 2020. The new government's decision to remove VAT on household electricity bills further dampens inflation expectations. As a result, most economists predict the Bank of England will hold its key interest rate at 3.75% on Thursday. However, the rate futures market is firmly betting on a 25-basis-point rate hike in November, driven mainly by the upside risk from oil prices.
The Bank of England is set to announce its interest rate decision, release meeting minutes, and publish its latest economic forecasts on Thursday, followed by a press conference with Governor Bailey. A Reuters poll of most economists expects the Monetary Policy Committee to vote 7-2 in favor of keeping rates unchanged, with no further adjustments expected for the rest of the year. This comes after June's UK CPI hit a 15-month low and private sector wage growth recorded its weakest pace since 2020. The new government, led by Prime Minister Andy Burnham, has made tackling the cost-of-living crisis its top priority, announcing the removal of VAT on household electricity bills. UBS economist Anna Titareva estimates this move will exert roughly 0.1 percentage points of downward pressure on inflation. Titareva is clearly betting on a rate cut, stating the next policy move will be a reduction, expected in February and April 2027. Despite the fundamental economic logic offering little support for a rate hike, Wednesday's interest rate futures data pointed to a 25-basis-point hike by the Bank of England in November, followed by another increase in March 2027.
This meeting coincides with the Federal Reserve's July decision, which sent shockwaves through markets with three dissenting votes favoring a rate hike. Fed Chair Warsh expressed a "zero tolerance" stance on inflation, and the global hawkish sentiment is narrowing the Bank of England's policy window. The simultaneous decline in CPI and wage growth, alongside fiscal support, provides the core justification for the Bank of England to hold steady. June's CPI fell to 2.6%, a 15-month low. The closely watched sticky inflation indicator, private sector wage growth, slid to 2.9%, its lowest level since 2020, indicating that the risk of labor market overheating continues to diminish. Fiscal policy cooperation has further widened the scope for action. The removal of VAT on household electricity bills is a key cost-of-living measure championed by the Burnham government since taking office. Building on this, the Bank of England has, in two of its three energy price and inflation persistence scenarios, revised down its peak inflation forecast for this year from 3.6%-3.7% in April to just above 3.25%. Nevertheless, UK inflation has been above the central bank's 2% target for most of the past five years. The MPC is closely monitoring whether the 2027 pay negotiations, set to begin later this year, will reignite wage demands. Most committee members currently judge that, given the weak labor market, the current interest rate level is sufficient to guide inflation gradually downwards.
A Reuters poll shows a majority of economists expect the MPC to vote 7-2 to maintain the base rate at 3.75%, with no change for the rest of the year. However, the rate futures market presents a starkly contrasting picture. It not only fully prices out any chance of a rate cut this year but also factors in a 25-basis-point hike in November and another increase in March 2027. The core logic driving this bet originates from energy prices. The Strait of Hormuz has been closed for five months, and while current oil futures are still at the low end of the Bank of England's scenarios, a sharp price surge above $100 per barrel last week has triggered market concerns about a rebound in inflation. Divisions within the MPC are also deepening. Chief Economist Huw Pill and external member Megan Greene are expected to continue voting for a hike, while Deputy Governor Clare Lombardelli and external member Catherine Mann are considered most likely to join them. Mann warned this month that falling market borrowing costs could make controlling inflation more difficult. Matthew Ryan, Head of Market Strategy at financial services firm Ebury, pointed out that the current oil price levels and recent economic data do not support the Bank of England rushing into a rate hike or issuing overly hawkish communication signals. Most MPC members believe that the overall tightening of financial conditions since the start of the Middle East conflict has, in effect, partially substituted for the need for further tightening action.
As previously reported, the Federal Reserve kept rates unchanged at its July meeting, but three members of the FOMC dissented in favor of a 25-basis-point hike. This internal division adds a new layer of uncertainty to the global monetary policy path. Governor Bailey previously stated that the Bank of England's signal in March to pause rate cuts was "expected to" control inflation. The tentative tone of this statement actually preserves flexibility for the policy path. On the operational front for the Bank of England itself, the pace of quantitative tightening has already been slowed from an annual £100 billion to £70 billion in 2025. Financial market participants expect the MPC may further reduce the pace of balance sheet reduction to £50 billion in September. The foundation of UK inflation is more fragile than that of the Eurozone. Energy prices have a higher transmission weight in the CPI basket, and wage stickiness in the labor market has not yet cleared. In this context, even if Thursday's decision is likely to maintain the status quo, the market's pricing for rate hikes constitutes a form of implicit tightening. Governor Bailey's wording during the press conference will be a key signal, testing the central bank's attitude towards current market pricing.
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