Divisions at the Bank of England: A Balancing Act

MPC: A Knife-Edge Cut

At its latest meeting, the Monetary Policy Committee (MPC) narrowly voted to cut the Bank Rate to 4.0% from 4.25%, with the decision passing by a razor-thin 5–4 margin. The closeness of the vote underscores divisions within the Committee, with an initial split of 4–4–1 requiring a re-vote. Governor Andrew Bailey stressed the need for a "gradual and careful approach" to easing, citing inflation risks and softer jobs data. Market pricing remains tentative: odds of another cut this year are around 50/50, with 1.5 cuts expected by mid-2026.

Recent GDP figures provided a temporary reprieve for the MPC, with the economy expanding 1.2% year-on-year compared with expectations of 1.1%. However, a closer look reveals a less robust picture. The bulk of the growth came from government spending, while private consumption was nearly flat and business investment slipped after front-loaded activity in Q1 ahead of new tariffs. The data offered some relief from stagflation concerns, but given the backward-looking nature of the data, it is unlikely to meaningfully shift policy outlook.

Cracks in the Jobs Market

The labour market remains under pressure and a thorn in the side of bankers and politicians alike. Since Chancellor Reeves’ previous budget, which raised employer costs through higher National Insurance contributions and a higher minimum wage, the economy has shed 165,000 jobs. While recent data show signs of stabilisation - just 8,000 jobs lost compared with 20,000 expected, and prior months revised less negatively - the unemployment rate remains at 4.7%. This marks the highest level since 2016 outside the Covid era. There are tentative green shoots, but persistent labour weakness will weigh heavily on the BoE’s policy calculus. 

Sticky Prices, Sticky Problem

On the other side of the policy see-saw, price pressures remain sticky. Latest figures show headline CPI rose 3.8% year-on-year, slightly above expectations of 3.7%, while services inflation climbed to 5%, exceeding the BoE’s own forecast of 4.9%. Although the surprise was largely driven by volatile airfares, elevated services and food inflation signal underlying persistence. Businesses continue to pass on costs from Reeves’ tax measures, keeping consumer prices high. The inflation dynamics threaten Prime Minister Starmer’s pledge to raise living standards, as any recovery in real incomes is being eroded by both higher costs and a cooling labour market.

The Fiscal Squeeze Tightens

Adding to Labour’s woes is the deteriorating fiscal situation. Reeves faces a budget hole estimated between £15 and £20 billion heading into the Autumn Budget. Her much-vaunted “stability rule” - that day-to-day spending should be covered by tax receipts within five years - is under strain. The £9.9 billion fiscal headroom declared in March has been eroded by sluggish growth, rising debt-servicing costs, and policy reversals. Notable U-turns, such as reinstating £1.25 billion in winter fuel payments and abandoning £5 billion in disability benefit cuts, have added to the burden and all but confirmed that the only route forward is higher taxation.

Fiscal sustainability concerns are colliding with higher borrowing costs. Long-dated gilt yields are testing politically sensitive highs not seen since 1998, surpassing levels from the Truss-era market turmoil. Thirty-year real yields now stand at 2.55%, with nominal yields at 5.6%. The back end of the curve is increasingly unanchored in a sign of higher inflation, higher debt environment. The nominal 2s30s curve has steepened nearly 100bps this year. Meanwhile, UK 10-year borrowing costs trade around 40bps above US equivalents - double the year’s average and 80bps above the five-year norm.

In FX, sterling remains largely USD-driven, but persistent inflation and elevated rates could provide some support, even if domestic challenges cap upside. Those looking to hedge GBP assets back to USD on a forward basis now face a cost of hedging from about 9m onward. Recent weeks have seen the UK/US interest rate differential widen as policy paths seemingly diverge. Whilst the factors supporting UK rates remaining higher are there, we see the greater risk to hedgers as a reconvergence of the rates. For that reason, now feels an opportune time to approach GBP hedging tactically.  

The UK economy is caught in a precarious balancing act. The BoE is under pressure to cut rates to support growth but remains constrained by sticky inflation. Reeves faces rising borrowing costs and a fiscal hole that limits her room for manoeuvre. With unemployment rising and inflation still eating into living standards, the political and economic challenges are mounting. For markets, the path forward is defined by ambiguity: an uneasy mix of softening growth, fiscal strains and inflation persistence. In such an environment, policymakers, investors, and risk managers alike must brace for volatility and an uncertain trajectory into 2026.