Bank of England Cuts Interest Rate to 4% After Unprecedented Split Vote, Signals Easing Cycle May End

The Bank of England's Delicate Balance: Rate Cut Signals End of Easing Cycle Amid Inflation Concerns

LONDON — In an unprecedented display of internal division, the Bank of England cut its main interest rate to 4% today after requiring a second round of voting to break an initial deadlock. The quarter-point reduction—the fifth since August 2024—comes with a striking caveat: this may be among the last cuts for the foreseeable future.

The narrow 5-4 decision, led by Governor Andrew Bailey against four dissenting voices, reveals a monetary authority caught between competing imperatives: supporting a fragile economic recovery while confronting inflation forecasts that have been revised sharply upward. The central bank now expects headline inflation to peak at 4% in September—double its mandated target.

"Today's vote was fractured along fundamental views about the balance of risks," said a senior economist at a major European investment bank, speaking on condition of anonymity. "The unprecedented second ballot tells you everything about how knife-edge this decision was."

Markets immediately recalibrated their expectations, with sterling strengthening and gilt yields rising as traders priced out the possibility of aggressive easing through year-end. The pound closed at $1.341 against the dollar, while two-year gilts finished at 3.89%.

The Dual Message: Cut Now, Pause Later

The nuance of today's action lies less in the rate cut itself—which brings borrowing costs to their lowest level since March 2023—than in the Bank's careful messaging. Gone from the policy statement is language describing monetary policy as "restrictive," a subtle but significant shift that signals the MPC believes rates are approaching more neutral territory.

For the approximately 590,000 homeowners with tracker mortgages directly linked to the Bank Rate, the cut delivers immediate relief—roughly £29 monthly on average repayments. However, the vast majority of UK borrowers on fixed-rate deals will see no immediate benefit.

The decision comes against a backdrop of deteriorating economic conditions. Business investment remains subdued amid geopolitical uncertainty, consumer spending has slowed markedly, and job-loss notifications have increased following employer tax hikes implemented last year. GDP growth is forecast at just 0.3% for the third quarter, reflecting an economy still struggling to find solid footing.

Yet inflation pressures remain stubborn. Core services inflation held at 5.1% year-over-year in June, while private-sector pay growth continues at 5.5% on a three-month annualized basis.

"The MPC is being forced to navigate between Scylla and Charybdis," said a veteran bond trader at a UK asset manager. "Cut too much, and you risk entrenching inflation expectations above target. Cut too little, and you could tip the economy into recession."

Inside the Decision: A House Divided

The extraordinary voting sequence revealed deep fractures within the nine-member committee. An initial vote produced a 4-4-1 split, necessitating a second round that ultimately delivered the narrow majority for a cut.

Two camps emerged within the MPC:

The "cut now, avoid recession" faction, led by Bailey and four colleagues, pointed to worrying signals: falling new-order PMIs, the impact of April's tax increases (equivalent to 1.3% of GDP), and rising layoffs across multiple sectors.

The "hold, inflation still hot" group, including Chief Economist Huw Pill and Deputy Governor Clare Lombardelli, focused on persistent food and administered price pressures, along with a concerning uptick in one-year inflation expectations to 3.3% in the latest Decision Maker Panel survey.

The compromise—cutting rates but signaling a potential pause if upcoming inflation prints remain sticky—reflects a delicate balancing act that has characterized Bailey's tenure.

Quantitative Tightening: The Hidden Influence

While the headline rate decision dominated attention, the Bank's ongoing quantitative tightening program represents an equally significant policy lever. The BoE's own analysis now estimates QT's impact on 10-year gilt yields at 15-25 basis points—higher than previous estimates of 10-20 basis points.

With nearly half of the £163 billion long-dated portfolio still to run off, market specialists anticipate the Bank will soon announce a reduction in active sales to approximately £60 billion for 2025-26, with a strategic emphasis on front-end stock rather than longer-dated issues.

"QT modulation is the stealth driver of curve steepening," noted a rates strategist at a global investment bank. "The shift away from 20-year-plus disposals will directly impact the yield curve, creating opportunities in steepener trades."

Market Mispricing and Investment Implications

The immediate market reaction has created potential value disparities, particularly in shorter-dated gilts. Front-end instruments now imply a terminal rate around 3.30%, with SONIA March 2026 contracts trading at 3.52%—levels that appear inconsistent with the BoE's own forecasts for economic slack and inflation.

For professional investors, several strategic opportunities have emerged:

Rates positioning: Short-term UK rates appear mispriced for a soft-landing scenario that still assumes persistent inflation. Receiving positions in SONIA contracts and ownership in the 3-5 year gilt sector offer value.
Curve strategies: The 2s/10s gilt spread, currently at 97 basis points, is likely to widen further as QT adjustments favor short-dated sales. Steepener positions offer positive carry and roll characteristics.
Sterling outlook: The pound's current strength may prove unsustainable once Federal Reserve easing accelerates. Tactical shorts via risk-reversals—buying 3-month 1.315 GBPUSD puts versus 1.375 calls—offer asymmetric payoff potential.
Credit and equity sector allocation: Investment-grade sterling credit spreads (currently around 125 basis points) continue to compensate adequately for downgrade risk, with BBB utilities appearing particularly attractive given their regulated cash flows and inflation pass-through mechanisms. Within equities, domestic banks stand to benefit from a rate floor above 3%, while housebuilders remain vulnerable until mortgage approval volumes stabilize.

Looking Ahead: Three Potential Paths

Looking forward 12-18 months, three distinct scenarios emerge:

The baseline case (60% probability) envisions three additional quarter-point cuts by Q2 2026, bringing the Bank Rate to 3.50%. Under this "sticky disinflation" scenario, core inflation would gradually decline to 2.7% while GDP growth remains tepid at 0.4% year-over-year.

An upside inflation shock (20% probability) would likely force the BoE to pause at 4% throughout 2026, particularly if energy prices spike and push headline inflation above 5%.

A downside growth shock (20% probability), potentially triggered by recession in the eurozone, could necessitate accelerated cuts to 2.75% by Q4 2025 as unemployment exceeds 5.5%.

The August 14th release of June wage data and redundancy notices represents the next critical catalyst, with private sector earnings growth above 5.3% potentially eliminating the possibility of a November cut. The August CPI print on September 18th will also prove crucial—a core reading below 4.2% would reopen the door to further easing.

The Long View: Policy Normalization Remains Distant

Today's decision marks a pivotal moment in the UK's post-pandemic monetary policy journey. Having hiked rates from near zero to 5.25% by late 2023 in response to the highest inflation in four decades, the BoE is now navigating the complex process of normalization.

Yet true normalization—returning to the BoE's estimated neutral rate of around 0.75% in real terms—appears distant. Even the most aggressive market forecasts, such as Morgan Stanley's projection of 2.75% by end-2026, leave rates well above pre-pandemic norms.

For now, the Bank of England continues its cautious, data-dependent approach—cutting rates today while simultaneously signaling that the era of predictable, sequential easing may be drawing to a close. In doing so, it has delivered a message that markets are still absorbing: monetary accommodation has its limits, even in a sluggish economy, when inflation remains the primary concern.

Investment Thesis

Category	Details
BoE Decision	Hawkish cut to 4%; policy stance marginally restrictive. Markets price +10-15bp, expecting one more 25bp cut by May 2026. Base case: shallow easing to 3.50% in Q2-26.
Key Drivers	Core services CPI (5.1% y/y), wage growth (5.5%), labor slack (unemployment 4.6%), weak GDP (-0.1% q/q). Split vote: Bailey (cut to avoid recession) vs. Pill (hold due to inflation).
Market Pricing vs. View	SONIA Mar-26 (3.52%, expect 3.00%), 2s/10s gilt slope (+97bp, expect >110bp), GBPUSD (1.341, target 1.30), inflation swap (3.05%, fair).
Tactical Trades	Rates: Receive SONIA Mar-26. Curve: 2s10s steepener. FX: Short GBP via risk-reversal. Credit: BBB utilities. Equities: Overweight banks, underweight house-builders.
QT Impact	QT adds 15-25bp to 10y yields. Expected: reduced active sales (£60bn in 2025-26), fewer long-dated sales → steepener support.
Scenarios (Prob.)	Baseline (60%): 3 cuts to 3.50%, core CPI 2.7%. Upside (20%): Pause at 4%, inflation >5%. Downside (20%): Cuts to 2.75%, jobless >5.5%.
Key Catalysts	14 Aug: Wage data. 18 Sep: CPI. 2 Oct: QT review. 6 Nov: MPC meeting. Nov-Dec: Autumn Statement.
Bottom Line	1) Front-end gilts mispriced—receive SONIA. 2) QT steepens curve—position 2s10s. 3) Short GBP. 4) Equity rotation to banks/insurers.

NOT INVESTMENT ADVICE