Bank of England Preview: Cut priced in but how low can the Old Lady go?

Key points

• Markets expect a 25bps cut to 4.25%

• Downside risks to inflation & growth suggest dovish bias

• Meeting comes as 17-month expansion in services ended in April

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TL/DR: Markets expect short, sharp cutting cycle but the BoE may end up going slower and lower.

While a 25bps cut is practically nailed on for Thursday’s meeting of the Monetary Policy Committee, some have called for the Bank to more aggressively with a 50bps move. This may be a step too far, albeit there are a couple of doves who could vote this way; but investors will be closely watching signals for the pace and depth of cuts. In particular, investors sitting on cash should pay attention to whether the market thinks rates will ultimately fall to 3.5%, or much lower. As we discussed last month, there are notable mid-cap stocks sitting on 6-9% dividend yields that seem well insulated from the macro backdrop and have them well covered at present (see table below).

Heading into the meeting this week markets expected three 25bps cuts from four meetings, and for rates to end the cycle about 100bps lower, at about 3.5%.

But there are a couple of problems with those assumptions. Going at that sort of clip – expecting cuts also in June or September as well as August – is faster than the one cut per quarter pace they seem to be relying on. It will likely require a bigger breakdown in the economic data than we are likely to see in the very near term – latest GDP figures were modestly encouraging but likely boosted by front-running of tariffs. Two, global central banks have been reluctant to commit to preemptive rate cuts in the face of tariffs and are sticking to a wait-and-see approach. Three, services inflation remains, at 4.7%, stubbornly high and the MPC is not keen to see this reaccelerate by being too quick to cut. 

But services inflation should materially fall in the coming months, which against the kinds of headwinds facing the UK, will allow the Bank to push forward with more rate cuts – perhaps more the market believes (deeper)- just over a longer time frame, ie slower, than maybe the markets expect. Moreover, recent FX moves - a stronger pound - and lower oil prices should be disinflationary. So might tariffs be if China dumps goods here.

Moreover, we are seeing cracks in the economy with survey data showing the UK’s services sector contracting in April. At 49.0, down from 52.5 in March, the S&P Global UK services PMI activity index was the lowest since January 2023. Consumer confidence readings have also slumped. Inflation has overall surprised on the downside – ie been lower than expected.

Watch for a shift in the formal guidance – if they remove the word “gradual” from the statement that a "gradual and careful approach to removing monetary policy restraint remains appropriate", then it could be seen as a prelude to consecutive cuts. Dropping the reference to gradualism could signal a quicker pace of easing, which would likely weaken the pound and lower gilt yields.

The market is poised for this and if it does NOT drop this reference it could be a hawkish tilt that the market is not quite expecting (sterling positive). On the side of the doves – tax hikes killing employment, energy prices falling, a stronger pound and tariffs. On the side of the hawks, natural caution and services inflation still at 4.7%, albeit down from 5% the month before. The other problem is that the ONS is not delivering good data, which complicates the picture for rate-setters. 

Question: Why should Britain have rates at 4.5%, the same as the US and double the 2.25% in the Euro area, given the risks to growth and the pressure on the economy that is so self-evident?

In short, while the BoE could be a touch slower than expected, it could ultimately end up lower than the market thinks for this cycle.

These are the UK stocks with the best 3-month performance and minimum 5% dividend yield.