Only two rate cuts left? The loose cycle of the Bank of England may be coming to an end.

The Bank of England is expected to cut interest rates this week, as the market anticipates, but this may force policymakers to confront a tricky problem: is the loose cycle that has been in place for less than a year and a half close to an end? Most economists and investors expect the Bank of England to announce a 25 basis points cut on Thursday, bringing the base rate down to 3.75%. Measures cited by the Bank of England Governor Bailey and other indicators indicate that the "neutral interest rate" in the UK is close at hand - a level that is believed to neither stimulate nor restrain inflation - and the current rate is only one to two rate cuts away from that level. Although most members of the Monetary Policy Committee of the Bank of England have been reluctant to indicate their neutral rate range, this concept has quietly become an important consideration in decision-making. Over the past few months, within this decision-making body of 9 members, hawks and doves have been evenly matched, with Governor Bailey becoming a key swing voter that decides the final resolution. The core disagreement within the Monetary Policy Committee lies in how to balance the persistently high inflation in the UK with the weakening labor market. As of October, UK inflation remains high at 3.6%. Since the start of this easing cycle in August 2024, the balancing forces of these two factors have made it difficult to push forward with rate cuts, and as the policy rate nears the neutral level, future rate cuts will be more challenging. Paul Dales, Chief UK Economist at Capital Economics, said: "From now on, the threshold for each rate cut will be significantly raised. Despite serious disagreements among the members, I cannot help but speculate that the almost 'inertia' rate cut pace that has been in place may come to an end." Traders are wagering that as major central banks around the world gradually approach their neutral levels, from Australia to the United States, central banks will pause or end their easing cycles in the coming months. Currently, loose fiscal policies, investments in artificial intelligence, climate change, and defense sectors are exerting upward pressure on long-term rates; while demographic changes and slowing productivity growth in recent decades have been pushing rates down, a trend particularly pronounced in the UK and Europe. Analysts from Morgan Stanley, Capital Economics, and other institutions believe that the continuous deterioration of economic prospects will further push policymakers to cut rates. Economists surveyed expect the Bank of England base rate to fall to 3.25% in the second half of next year. In contrast, investors' expectations are more pessimistic, betting that the final base rate will stabilize at around 3.4%. This means that if the Bank of England cuts rates next week as expected, policymakers will have only one more 25 basis points rate cut left - further cuts may face the risk of stimulating inflation rebound. Economists Dan Hanson and Ana Andrade said: "The Bank of England removed the 'prudent' wording in its policy guidance in November. We expect the wording of the Monetary Policy Committee in December to remain largely unchanged, still adhering to the stance of 'further easing should be gradual.' This wording may reflect the uncertainty of the committee about the neutral rate level - the end point of this ease cycle. We expect the Monetary Policy Committee to adjust its policy guidance in April next year, announcing a 25 basis points rate cut, lowering the base rate to 3.5%. At that time, most policymakers may judge that the Bank of England's policy stance is basically at a neutral level." The only member of the Monetary Policy Committee who clearly gives a neutral rate range is Alan Taylor, who believes it is 2.75% to 3%. Taylor is one of the most dovish members of the committee, advocating that trade frictions and slowing economic growth will bring stronger deflationary pressures to the UK economy. Officially, the Bank of England only acknowledges a neutral rate range of 2% to 4%. Even Deputy Governor Clare Lombardelli, responsible for monetary policy, admitted last week that this range is "quite broad". She and some committee members believe that it is difficult to accurately estimate the specific level of the neutral rate, but what can be confirmed is that the current neutral rate is higher than it was before the pandemic. Andrew Goodwin, Chief UK Economist at the Oxford Economics Research Institute, said: "The Bank of England is intentionally downplaying the explicit definition of the neutral rate, so that policymakers have maximum flexibility, whether they want to adjust rates above or below the neutral level. To make things worse, there are two clearly divided camps within the committee, each with 4 members standing firm, and Bailey constantly wavering in between, making the decision-making process much more difficult." Currently, of the 9 members of the Monetary Policy Committee, Lombardelli and Chief Economist Huw Pill, among others, are hawks, while Deputy Governor Dave Ramsden, Sarah Breeden, and others are doves. This deadlock makes Bailey's position particularly crucial. Bailey has admitted that he belongs to the camp that "lacks enough confidence in determining the neutral rate". However, his statement in November still attracted widespread attention - at that time, he clearly stated that the path of adjusting policy rates is basically in line with the Taylor rule proposed by American economist John Taylor. According to this rule, the Bank of England's base rate will fall to 3.3% and eventually stabilize slightly higher at 3.5%. The market's expectation of the final rate level (currently slightly below 3.5%) will directly determine the pricing of fixed-rate mortgages by commercial banks. If borrowing costs continue to fall, it will ease some pressure for the UK Labour government - which has promised to address high living costs. Chancellor Rachel Reeves introduced several measures to curb inflation in last month's budget, partly also in order to push the Bank of England to further ease monetary policy. Bailey emphasized that the two rounds of inflation and employment data released between the meetings in November and December are crucial. The first round of data shows a slight easing of inflation pressures, and the second round of data will be released before the interest rate decision on Thursday this week. The Bank of England expects that the inflation data for November released on Wednesday will show a 0.2 percentage point decrease to 3.4%. Goodwin pointed out: "If the data unexpectedly rises, it may disrupt the deployment at the last minute."