Since the release of the UK’s September inflation data two weeks ago, expectations for this week’s Bank of England (BoE) rate decision have shifted markedly, from a near-certain rate hold to a more uncertain outlook.
Before the CPI figures were published on 22 October, markets saw only a 12% chance of a 25-basis-point rate cut on 6th November. That probability has now climbed to roughly 33%, prompting Goldman Sachs to revise its forecast and project a likely 25bp cut.
Despite the marginally more optimistic inflation data – 3.8% rather than the forecast 4% – the headline figure remains well above the BoE’s 2% target. Given the overall state of the UK economy and the Bank’s preference for market stability, no change in rates this month, and possibly even this year, seems more likely.
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At 3.8%, inflation has likely peaked for now. The UK’s 4.8% unemployment remains relatively low compared with other developed economies but has risen over the past 12 months. More concerning is the decline in job vacancies. Real GDP growth is stagnant at 0.3% signalling weak demand, and public sector net debt at around 95.3% of GDP is high and continues to rise. Borrowing in the first half of fiscal 2025/26 reached £100 billion.
The BoE faces a stagflation-lite situation and will want to avoid further inflating borrowing through aggressive easing. Such a move could further weaken sterling (it lost 2.6% in October against a basket of currencies) and exacerbate import-driven inflation.
In the current setup, the Monetary Policy Committee (MPC) is likely to prioritise price stability over growth or employment, especially given sticky services inflation at around 5.4% and still elevated wage growth. It remains to be seen what the Autumn Budget will bring at the end of November. If it does introduce the expected tax hikes and spending cuts, this could stifle the already slow growth even further and endanger the health of the labour market.
Market pricing
Interest rate swaps currently imply a 33% chance of a 25-bp cut this week, while futures prices are holding at 4%. A December cut appears slightly more likely, with odds of 70%. Despite Goldman’s pivot, market consensus remains for the first cut to come in February next year.
The long and the short of it
Last week, yields nudged 10-20 basis points lower across maturities, with the 10-year gilt yield posting its largest weekly drop since April. However, there was a brief spike on October 30 tied to political uncertainty over potential tax hikes.
If the BoE holds the rate at 4% this week, yields will likely stabilise around current levels, though gilt prices may remain volatile due to factors like quantitative tightening. Long-term gilt yields could decline slightly, influenced more by global factors than domestic policy. New gilt issuance will continue at higher yields to reflect the current interest rate environment.
Going forward, the yield curve may steepen: if short-term rates fall but longer-term yields decline less, or even rise due to inflation and fiscal risk, then the gap between long and short maturities will widen. Supply is likely to remain ample, not only because of the government’s future borrowing but also due to the BoE planning to sell down £70bn of government bonds from its stockpile over the next twelve months.
The next six weeks could be eventful for gilt investors.
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