BoE and ECB cut rates but plot different paths forward

Bank of England

The BoE’s decision to cut rates highlights the Bank’s commitment to supporting economic stability amidst both domestic and international headwinds. Voting 8–1 in favor of the cut, the MPC remains divided on the inflation outlook. Catherine Mann, the sole dissenter, voted to hold rates, reflecting a cautious view on inflationary risks, having recently warned of potential structural persistence in the relationship between U.K. wages and price formation. However, most Committee members appear confident that inflation is on the right track, with the latest official data showing U.K. headline inflation fell to 1.70% in September, the lowest level since April 2021.

The market reacted to the BoE’s rate cut with gains for the pound, as traders scaled back their rate cut forecasts for next year and U.K. government borrowing costs eased slightly. The BoE’s revised inflation forecasts contribute to its cautious stance, projecting CPI inflation at 2.70% within the next year — up from August’s 2.40% forecast. This increase reflects anticipated impacts from higher government spending and global trade changes. The Bank expects inflation to stay above its target over the next two years, suggesting sustained inflationary pressures bolstered by Chancellor Rachel Reeves' recent £70B increase in government spending. The BoE estimates that the budget will add approximately 0.50% to inflation at its peak between mid-2026 and early 2027, with private sector wage growth forecast to remain high at 5.00% through the current quarter of 2024.

The decision reflects the Bank’s complex position, with sizeable risks arising from U.S. trade policy shifts and increased global economic uncertainty that are likely to place external pressures on the U.K. economy. Meanwhile, the BoE’s revised GDP growth suggests a modest expansion of 1.00% in 2024, down from the previous 1.25% forecast in August, possibly justifying further easing to support economic growth. Governor Bailey’s emphasized a measured approach to further rate reductions, to avoid cutting too quickly or too steeply amid ongoing inflation risks.

European Central Bank

The ECB’s decision to cut rates by a further 25 basis points, following a 25-basis-point cut in September, signals a proactive response to slower economic activity across Europe, including weak manufacturing output and declining exports. President Lagarde pointed to softer than expected economic data, noting that Germany's contraction in the second quarter as influenced by the decision. The market reacted with a weakening Euro, while borrowing costs fell and investors priced in a faster pace of rate cuts.

Following the decision, Lagarde said that the disinflationary process across the bloc was “well on track,” with all recent data pointing to lower consumer prices. Headline inflation fell more than expected to 1.70% in September, which President Lagarde said had surprised the Central Bank and necessitated the rate cut to ensure a soft landing for the eurozone economy. “The latest (economic) data is all heading in the same direction, downwards, and points to more sluggish growth,” she added.

However, core inflation remains above target and ticked up slightly according to October’s flash estimate, with wage growth and labor cost as areas the ECB must consider as it eases monetary policy. Additionally, the Central Bank’s forecasts show inflation is projected to rise modestly in the near term, before stabilizing at the 2.00% target next year. Despite generally disappointing economic data, Lagarde emphasized that the Governing Council does not view a recession in the eurozone as the most probable scenario: “We are looking at a soft landing.” The ECB gave little guidance over the future path of its monetary policy, reiterating that it would take a “data-dependent approach” and was not pre-committing to a particular rate path.

Moving forward

Looking ahead, market projections indicate that the BoE will cut rates by less than both the ECB and the Federal Reserve, with a little under three 25-basis-point rate cuts expected next year. This would leave the bank rate at or above 4.00%, which would likely weigh on output, especially with the additional fiscal burden the U.K. budget places on companies. With weak eurozone growth and the potential for protectionist policies from a new U.S. administration, the BoE will likely hope that inflation subsides quicker, allowing for a faster pace of monetary easing in 2025.

Markets have quickly priced in the prospect of additional monetary easing by the ECB, following President-elect Donald Trump’s victory in the U.S. election and his plans to introduce tariffs on EU imports. Markets will closely monitor the ECB for any indications of how Trump’s re-election might impact eurozone interest rates, though Lagarde’s emphasis on a “meeting-by-meeting” approach suggests that the Bank will refrain from pre-committing. Markets are currently pricing in 25-basis-point rate cuts at the next four ECB meetings, which would bring rates back to the lowest level since the end of 2022.