"Stagflation" alarm sounded, will the Bank of England lower interest rates tonight or is there uncertainty?

According to the Zhitong Finance APP, the Bank of England is expected to announce its third interest rate cut this Thursday (February 6) while lowering its economic growth forecast for the UK in its quarterly report and predicting that inflation will rise this year. This report may put Chancellor Rachel Reeves in a difficult position.

Economists and traders generally expect the Monetary Policy Committee (MPC) to lower the benchmark interest rate by 25 basis points to 4.5%, which would be the lowest level since June 2023. A survey indicates that the voting outcome may support the rate cut by a majority of 8 to 1.

Growth and Inflation Forecasts

In the quarterly monetary policy report, the Bank of England will update its economic growth and inflation forecasts and provide its latest estimates on how quickly the economy can grow without triggering inflation. Dan Hanson and Ana Andrade from Bloomberg Economics believe the Bank of England will set the potential growth rate at 1%-1.5%, consistent with last year's estimate of 1.5%.

Most economists predict that actual growth for 2025, 2026, and 2027 will be downgraded. The downgrade for 2025 is due to poor economic performance, while the downgrades for the following years are based on a market interest rate path that is tighter than expected in November of last year.

Economists surveyed believe that this year's inflation forecast will be raised due to food and energy prices being more stubborn than expected. This indicates that the UK is falling into a "stagflation" predicament, putting significant pressure on Reeves after her important speech on economic growth. Due to the tightening of the market interest rate path, inflation expectations for 2026 and 2027 will be downgraded.

Voting Discrepancies

In the voting of the Monetary Policy Committee, it is expected that only one member will oppose the rate cut and call for maintaining the interest rate at 4.75%. This member is external committee member Catherine Mann, who has been the most hawkish member. Another external member, the most dovish on the committee, Swati Dhingra, may vote in favor of a 50 basis point rate cut.

Analysts at Royal Bank of Canada stated that at the last meeting in December, the committee adopted a "dovish hold" strategy. Three members voted in favor of the rate cut, and the tone of the meeting minutes indicated increasing concerns about the economic outlook. Since then, the situation has further deteriorated, with the economy stagnating and the labor market weakened due to the tax increase budget proposed by Reeves on October 30

Interest Rate Bets

The Bank of England faces a tricky communication challenge, as market interest rate paths have been volatile since last November due to uncertainties in U.S. policy and its spillover effects on the UK, as well as budget impacts. In November and December of last year, Bailey seemed to suggest that four rate cuts to 3.75% this year would be appropriate. However, the Bank of England's February forecast for the interest rate path anticipates only two rate cuts, while the market has now priced in three rate cuts.

If the Bank of England's forecast shows inflation rates significantly below the 2% target, it could mean that more than two rate cuts may be needed by 2025. An accommodative monetary policy would imply that economic growth will outpace its forecasts.

Outlook Guidance

The Bank of England is almost certain to stick to its wording, suggesting a cautious approach to easing policies, especially following the uncertainty triggered by U.S. President Trump's announcement of comprehensive tariffs. The Bank of England has stated that "gradual" means four rate cuts of 25 basis points each this year. Given the hawkish tendencies in the market since last December, maintaining the current guidance would effectively be a rebuttal to market expectations.

Sonali Punani, an economist at Bank of America for the UK, stated: "In our view, it is still too early for a decisive dovish shift in February, as inflation may rebound in the coming months, coupled with rising inflation expectations indicating persistent risks."

Others are more focused on signs of weakness in the labor market. Sanjay Raja, an economist at Deutsche Bank for the UK, noted: "The unemployment rate may rise more quickly, with the Bank of England's unemployment rate forecast rising to 4.6%. The Monetary Policy Committee may send a slightly dovish message, signaling more clearly towards rate cuts."

The Bank of England has refused to disclose its estimate of the neutral interest rate. The latest member of the Monetary Policy Committee, Alan Taylor, believes the neutral rate is around 2.75%. A survey shows that most respondents believe the neutral rate is between 3% and 3.5%.

Budget and Tariffs

The Bank of England has stated that it will conduct a comprehensive assessment of the budget in February. Signs indicate that a larger portion of the £26 billion ($32.6 billion) increase in national insurance contributions will be passed on to consumers through price increases, more than initially assumed by the Bank of England, thereby pushing up inflation. The Bank of England may also evaluate a series of growth measures announced by Reeves last week, including the construction of a third runway at Heathrow Airport.

Due to the U.S. tariff policies on Mexico, Canada, and China being implemented later than expected, they were not included in the Bank of England's forecasts (Trump has temporarily lifted tariffs on Canada and Mexico, but the threat remains if these countries do not meet U.S. demands on border security) Bailey may reiterate his preference for free trade. He stated in November last year: "I acknowledge that I am essentially an old-fashioned free trader. Openness to the trade of goods and services affects productivity by promoting competition, innovation, and specialization."