BOE Preview: UK economic recovery paused, high unemployment concerns, interest rates expected to remain unchanged

Due to policymakers weighing the conflicting signs of a strong economy and unemployment near its highest level in five years, it is expected that the Bank of England will maintain the interest rate at 3.75% this Thursday. Since August 2024, the Monetary Policy Committee has been cautious, having previously lowered the interest rate from 5.25%. While the nine members still have differing views on the ultimate target interest rate economists estimate the "neutral" rate to be between 3% and 3.5% minutes from the December meeting indicated that they have agreed to slow the pace of rate cuts unless unexpected circumstances arise. The biggest unknown for the Bank of England currently is the speed at which inflation will decline from the current 3.4% to the 2% target, as well as whether the recent softness in the labor market signals the start of more serious issues. The Bank of England expects inflation to fall back to the target level of 2% in the next quarter. The Bank of England will announce its latest interest rate decision on February 5th, along with the quarterly Monetary Policy Report containing a series of new economic forecasts that will aid in understanding the Bank's judgment, with wage prospects being a key factor. The results of the Bank's survey of business contacts, which is crucial for planned compensation schemes, will also be closely watched. Barclays Bank's Chief UK Economist Jack Meaning wrote in a report, "The labor market is at the core of the current policy debate." As of November, the unemployment rate in the UK remained at 5.1%, the highest level since the beginning of 2021. This means that by the end of 2025, the unemployment rate will be higher than the 5% forecasted by the Bank of England in November. Meanwhile, Meaning indicated that wage growth is expected to remain below the Bank's expectations for the fourth consecutive quarter. Despite concerns about the unemployment rate, the Monetary Policy Committee is expected to keep interest rates unchanged until there is more concrete evidence that inflation can sustainably reach 2%. Capital Economics warned that an increase in oil prices following US President Trump's threats against Iran could raise UK inflation by 0.2 percentage points. With signs of economic recovery following consecutive tax hikes under the Labour government, the Monetary Policy Committee members may downplay concerns about employment. Investec economist Philip Shaw stated that recent data "does not support a rate cut this time." GDP grew by 0.3% in November, and the Purchasing Managers' Index (PMI) reached a 21-month high, with "neither showing signs of excess capacity." Barclays Bank and Investec predict a 7-2 vote in favor of maintaining the interest rate by the Monetary Policy Committee (MPC), with external members Allen Taylor and Swati Dingra expected to vote against, supporting a rate cut. Morgan Stanley, on the other hand, predicted a 6-3 vote, with Deputy Governor Dave Ramsden also expected to join the opposition. Traders widely believe that there will only be one more rate cut this year, with almost zero possibility of a cut this week, a view shared by economists. Last December saw a rate cut of 25 basis points, ultimately decided by Bank of England Governor Andrew Bailey's casting vote with a narrow 5-4 majority. It is expected that the quarterly forecasts will not show significant changes compared to the assessment in November last year. Analysis indicates that the economic growth outlook for 2026 will remain at 1.2%. Inflation is expected to decrease substantially, stabilizing around 2% from June onwards, reflecting budget decisions to cancel climate and social levies on household energy bills and freeze railway ticket prices. Morgan Stanley's Chief UK Economist Bruna Skarica suggested that the Bank of England may try to steer the discussion towards threats to the economy and stable inflation, analyzing the impact of trade shifting towards China and how different wage growth trajectories will affect the Monetary Policy Committee's decisions. The Bank has recently added some scenario analyses to highlight hot-button issues that could impact policy.