Market Update: Divided BoE settles on another rate cut

Highlights: In a 5-4 vote, the MPC opted for a 25bps rate cut from 4.25 per cent to 4.00 per cent, with four members voting for no change. GBP gained against the dollar following the decision, while gilt yields rose as investors scaled back their expectations. A re-vote was required to reach the ultimate decision – a rare move in the MPC’s 28-year history and underscores the challenging macroeconomic backdrop the UK faces.

• The Bank of England (BoE) cut interest rates to 4.00 per cent, marking the lowest level in over two years. The decision followed an unprecedented re-vote after an initial deadlock among policymakers, highlighting the deep division within the Bank's Monetary Policy Committee (MPC). Governor Andrew Bailey described the situation as one of 'genuine uncertainty,' particularly given the balancing act between persistent inflation, now expected to peak at 4.00 per cent in September, and signs of labour market softening
• Ultimately, it does come to a matter of timing, with “second round” effects a risk amid the summer hump in inflation. The BoE is still a little unsettled by the elevated services inflation and note that inflation expectations of households and businesses are higher than they would like. Presumably, four MPC members reasoned that it would be better to clear September’s peak inflation before easing so that they can keep a lid on expectations. While the BoE bumped up their inflation forecast, they expect the US tariffs will be modestly disinflationary over the medium term while having only a marginal impact on growth
• Bailey reiterated the need to not cut too quickly or too much, despite confirming that policy remains on a downward path. Markets anticipate the Bank Rate could decline to around 3.50 per cent by year-end, assuming inflation stabilises and the labour market remains soft. We forecast the BoE will continue to reduce Bank Rate at a continued 25bps-per-quarter pace, until it gets to 3.00 per cent in Q3 2026
• We maintain a mild overweight stance on UK gilts as they still offer relatively attractive value compared to global peers, especially as yields are expected to decline further into 2026. In our view, the Bank Rate can fall much closer to 3.00 per cent before the BoE feels comfortable that rates are no longer restrictive. This implies that bond yields can fall from here, making gilts with a 7-10-year duration an attractive investment, in our view