MPC rebels overruled as UK interest rates held at 4.25%

After yesterday’s news that UK inflation had remained sticky in May, today’s interest rate decision seemed a formality.

In line with expectations, the Bank of England’s Monetary Policy Committee (MPC) indeed maintained the Bank Rate at 4.25%, as fresh threats to UK price rises emerge, notably from the Middle East conflict.

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But the verdict was far from unanimous. Despite inflation running far higher than the Bank’s 2% target, some policymakers were in favour of dropping interest rates.

The Bank’s rate setters voted by a majority of six to three to keep rates where they are. The trio of dissenters – Swati Dhingra, Dave Ramsden and Alan Taylor – preferred a 0.25 percentage point cut to drop rates to 4%.

The Bank said that global uncertainty remains elevated. “Energy prices have risen owing to an escalation of the conflict in the Middle East. The committee will remain sensitive to heightened unpredictability in the economic and geopolitical environment, and will continue to update its assessment of risks to the economy.”

Inflation outlook

Yesterday it was revealed 12-month inflation stayed steady at 3.4% between April and May; April’s figure was originally registered at 3.5% but the Office for National Statistics (ONS) admitted an error earlier this month.

On a more promising note, 12-month core CPI, which strips out energy, food, alcohol and tobacco, eased from 3.8% to 3.5%, while services CPI cooled from 5.4% to 4.7%, after spiking the month before.

Even though the MPC is more concerned with the medium-term outlook than the monthly data, it weakened the case for cutting rates today, especially with price rises expected to creep up later this year.

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The consumer prices index (CPI), the UK’s main measure of inflation, is expected to remain just under 3.5% for the remainder 2025, briefly shunting up to 3.7% in September, according to Bank forecasts. Inflation is expected to ease back towards the Bank’s 2% target from next year.

“This profile was broadly unchanged from the projection made at the time of the May Report, although the pass-through to prices from National Insurance contributions, from regulatory changes and from some food input costs continued to require monitoring,” signalling the picture may change over the coming months.

Rate cut in August?

The market is pricing in two further rate cuts in 2025, bringing the Bank Rate down to 3.7% by year end. Borrowers crying out for cheaper mortgage rates will hope one arrives when the MPC announces its next decision, and the odds look favourable. Before today’s announcement, financial markets priced in a 77% chance of a 25-percentage point cut in August cut, but this has since risen to 84%.

However, Andrew Wishart, senior UK economist at Berenberg, pointed to “hawkish caution in the minutes” to suggest a further hold might be on the cards.

“Survey data hinting at a recovery in labour demand suggest that the deterioration in the labour market will not get any worse once firms complete their adjustment to the policy-induced increase in staff costs in April. As companies pass those costs on, inflation is likely to prove too stubborn for the Bank to cut again this year.”

Since kick-starting the rate-cutting cycle in August 2024, the MPC has adopted a cautious approach, alternating between reductions and holds. And the Bank today reaffirmed this stance, keeping an eye on the data as it unfolds.

“There remain two-sided risks to inflation. Given the outlook, and continued disinflation, a gradual and careful approach to the further withdrawal of monetary policy restraint remains appropriate.”

Fresh threats to inflation emerge

Israel’s conflict with Iran has shunted up the cost of oil, which may keep UK inflation elevated for longer than expected, weakening the case for interest rate cuts.

Crude oil was around $60 a barrel at the start of the month but has since climbed above $76 – a rise of more than 23% – at the time of writing.

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This has given the Bank a fresh challenge to contemplate, in addition to those posed by April’s hike to employer national insurance (NI), minimum wage hike, stubborn wage growth and Trump’s tariff wars.

But any caginess here on policymakers’ part must be balanced against the UK’s struggling economic growth, which could be stimulated by lower borrowing rates.

In a blow to the government’s growth ambitions, the domestic economy shrank by 0.3% in April, coming in worse than expectations. The MPC made note of this in today’s report, and remained wary of how wage growth might influence the trajectory of price rises.

“Underlying UK GDP growth appears to have remained weak, and the labour market has continued to loosen, leading to clearer signs that a margin of slack has opened up over time. Measures of pay growth have continued to moderate and, as in May, the committee expects a significant slowing over the rest of the year. The committee remains vigilant about the extent to which easing pay pressures will feed through to consumer price inflation.”

Mixed picture around the globe

Central banks in other parts of the world face contrasting circumstances and are subsequently adopting different approaches to monetary policy.

The US Federal Reserve yesterday held interest rates in benchmark range of 4.25-4.50%, resisting calls from President Donald Trump to wield the axe. US inflation marginally accelerated from 2.3% to 2.4% between April and May.

Isaac Stell, investment manager at Wealth Club, felt that Trump may have talked himself into a bind with policymakers.

“By making it crystal clear that he would like to see rate cuts, the president has put the Fed in a position where cutting rates makes it look it like the FOMC [Federal Open Mark Committee] has bent to presidential pressure. Central bankers tend to jealously guard their independence, which means that unless there’s a really compelling reason to cut they might just stay sat on the fence.”

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The European Central Bank (ECB) has taken a more aggressive approach, lowering rates for the eighth time in a year earlier this month. With the benchmark rate halving from 4% to 2% in the past 12 months, ECB President Christine Lagarde signalled the rate-cutting cycle is drawing to a close.

We should note that inflation in the eurozone is in better shape than the UK, and to a lesser extent the US, falling to 1.9% in May, below the ECB’s 2% target.

The Swiss National Bank faces a starkly different scenario. Swiss inflation nudged into negative territory last month, forcing policymakers today to drop interest rates by 0.25 percentage points to zero. And this strategy may not prove transient. Inflation is expected to average 0.2% this year, 0.5% in 2026 and 0.7% in 2027, with rates forecast to remain at rock bottom throughout this period.

How should investors react?

When it comes to the longer-term assets in your portfolio, such as equities, today’s interest decision alone shouldn’t prompt you to take a different approach.

A bigger consideration is the ongoing uncertainty. Trump’s tariffs pause ends on 9 July – except for China – and the president’s erratic nature means the action he’ll take is unknown. Elsewhere, the duration of Israel’s confrontation with Iran is also unclear and could have implications for the direction of global markets, particularly if the recent sell-off ramps up.

For investors with extended time frames, often the best approach is to block out the short-term noise and remain focused on the bigger picture. If markets wobble again, like we saw in April, buying opportunities may arise for savvy stock pickers.

The good news today is that your cash savings will continue to attract inflation-beating returns, although you might need to shop around to find them. But it’s worth remembering that holding too much cash for long periods can drag on portfolio performance, potentially causing harm to your hard-earned wealth.