The Bank of England keeps interest rates unchanged as expected and slows the pace of balance sheet reduction.

On Thursday, the Bank of England kept its policy rate unchanged at 4.00%, in line with market expectations. Seven members voted to keep the rate unchanged, while two (members Dinghra and Taylor) voted in favor of a rate cut. Meanwhile, the Bank of England reduced the pace of quantitative tightening from 100 billion pounds to 70 billion pounds, also in line with market expectations. This marks the first time it has slowed the pace of quantitative tightening since it began reducing its holdings of UK government bonds in 2022.

After the Bank of England's rate decision was announced, GBP/USD fell more than 30 pips in the short term. Traders maintained their bets on the Bank of England's rates, expecting another 6 basis points of rate cuts this year.

The Bank of England's latest rate decision stands in stark contrast to the Federal Reserve, which earlier announced a rate cut and projected further rate cuts ahead.

However, the Bank of England warned in its guidance that future rate cuts would be "gradual and cautious" and "depend on the extent to which underlying disinflationary pressures continue to ease." The report stated, "The upside risks to medium-term inflation pressures remain prominent in the Committee's assessment."

"Although we expect inflation to return to the 2% target, we are not out of the woods yet," Bank of England Governor Bailey said in a statement.

Regarding the slowdown in balance sheet reduction, Bailey stated, "The new target means the Monetary Policy Committee can continue to reduce the size of the balance sheet in line with its monetary policy objectives, while continuing to minimize the impact on the UK government bond market."

Between 2009 and 2021, the Bank of England purchased 875 billion pounds of government bonds to stimulate the economy. At this meeting, Bank of England Chief Economist Pill voted to keep the reduction at 100 billion pounds, believing that the balance sheet reduction process has little impact on the market. Monetary Policy Committee member Mann, on the other hand, called for an acceleration of the reduction to 62 billion pounds. The Bank of England stated that over the next year, the sale of short-, medium-, and long-term UK government bonds would be allocated in a 40:40:20 ratio.

Institutional analysts said that the Bank of England's decision today to withdraw from "competing" with the government in the UK government bond market—specifically by reducing the scale of its long-term bond sales—amounts to an admission that its previous operations have harmed public finances. With the current UK inflation rate hovering around 4%, a rate cut in the short term is impossible.

The Bank of England stated that more progress has been made in easing wage pressures than price pressures, but noted that the recent rise in inflation may put greater pressure on both.

Previously, official data released this week showed that the UK inflation rate is almost double the Bank of England's 2% target, and there are signs that the job market is stabilizing.

Although the Bank of England has pointed out that the cooling labor market and economic weakness are the basis for "future price pressures to ease," recent data show that after Chancellor Rachel Reeves raised employer payroll taxes and the minimum wage in April this year, the labor market has stabilized.

UK economic growth has also outperformed expectations: in the first half of the year, economic growth ranked among the top in the G7. The Bank of England has now raised its GDP growth forecast for the third quarter from 0.3% to 0.4%.

There are serious divisions within the Bank of England over "how to respond to a new round of inflation surges triggered by rising energy and food prices." Currently, UK households' inflation expectations are rising, and some officials are concerned that this could trigger a "feedback loop": inflation expectations drive up wage demands, which in turn lead to further price increases.

The Bank of England expects that the inflation rate will rise to 4% this month, with this data to be released about two weeks before the Monetary Policy Committee (MPC) meeting in November. Officials are particularly concerned about the spiraling rise in food prices, as it has a significant impact on consumers' lives.

Institutional Analysis

S&P Chief UK Economist Marion Amiot said: "As expected, the Bank of England did not opt for a rate cut, and the possibility of further monetary policy easing this year is slim. It is increasingly clear that companies are responding to rising labor costs—driven by higher minimum wage standards and increased employer National Insurance contributions—by laying off workers. At the same time, squeezed profit margins and stagnant productivity have exacerbated the situation. Strong wage growth indicates that these trends are pushing up the structural unemployment rate, and it also means that once economic activity picks up, the risk of entrenched high inflation becomes more likely."

Lloyd Harris, Head of Fixed Income at London investment firm Miton Investors, believes that the UK has now become the developed world's most severe 'stagflation' economy—caught in the grim situation of high inflation, low growth, and rising unemployment. Current government policies have not curbed stagflation, but rather exacerbated the problem: rising employer costs and increased taxes have both pushed up inflationary pressures and slowed economic growth. The next key event for the Bank of England and all GBP asset markets is the Autumn Budget. If, as expected, the government continues to raise taxes, the Bank of England may have to continue dealing with the current tricky stagflation situation.

Goldman Sachs analyst Simon Dangoor said in a report that whether the Bank of England can cut rates further for the rest of the year depends on the outcome of the UK's Autumn Budget in November. Persistently high (sticky) inflation and the easing of labor market weakness should have prompted the Monetary Policy Committee to abandon easing policies; but if this budget is seen as further dragging down the UK's economic growth outlook, it may prompt the (Bank of England) to take swift action (i.e., cut rates). However, he noted that overall, the Bank of England is unlikely to resume rate cuts until February 2026.