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The Bank of England is expected to hold interest rates steady as inflationary pressures persist.

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Interest rates are expected to be held at 4.75% by the Bank of England on Thursday, despite signs of a slowing economy, as a “gradual” approach towards cutting borrowing costs is constrained by persistent inflation pressures.

Uncertainty about the extent of rate cuts next year has been heightened in financial markets, following data released on Tuesday showing an unexpected acceleration in wage growth. Late on Wednesday, investors priced in only a 50% chance of a rate cut in February and anticipated just two cuts for the whole of 2025.

In contrast, rates have been reduced by 1 percentage point by the European Central Bank in 2024, with further reductions by another percentage point in 2025 expected by markets, as the euro zone economy is impacted by political turmoil and the risk of a U.S. trade war.

The divergence in interest rate outlooks has been highlighted by the yield difference between British and German 10-year government bonds, which has been pushed to its widest since 1990.

While the U.S. Federal Reserve is only expected to lower rates twice next year, a cumulative 1 percentage point of policy loosening in 2024 has been implemented with its rate cut on Wednesday, doubling the pace of the Bank of England so far.

The message that “a gradual approach to removing policy restraint remains appropriate” was reaffirmed by Governor Andrew Bailey earlier this month.

The Bank of England’s November forecasts, which indicated inflation remaining slightly above the 2% target until 2027, were based on market expectations of four rate cuts next year.

Explicit statements about whether this pace of cuts is viewed as the most likely scenario have not been made by BoE officials.

In December’s policy statement, a vaguer message of gradualism is expected to be maintained by the BoE, according to economists.

In a note to clients, it was stated by Bank of America analysts that it is believed to be too early for the BoE to pre-commit to a sustained cutting cycle or to conclude that risks to inflation returning sustainably to the 2% target in the medium term have dissipated.

Inflation and wage growth remain elevated, raising concerns for the Bank of England. British consumer price inflation, which peaked at a 41-year high of 11.1% in October 2022, fell below the BoE’s 2% target for the first time in three and a half years in September but rose again to 2.6% in November. This rate, exceeding the BoE’s forecast of 2.4%, was the highest among the Group of Seven advanced economies.

Services price inflation, regarded by the BoE as a better indicator of medium-term price pressures, was recorded at 5.0%. However, the more significant concern is wage growth, which reached an annual rate of 5.2% in the three months to October, far above the 3% rate deemed consistent with 2% inflation by most MPC members.

The decision by finance minister Rachel Reeves to impose an additional £25 billion ($32 billion) in employment taxes on businesses is being closely monitored by the BoE for its impact on prices, employment, and wages. Business sentiment has declined since the Oct. 30 budget, with economic output falling for two consecutive months for the first time since 2020.

While most economists suggest it is too early to determine if the slowdown will significantly reduce inflation, cautious optimism remains the prevailing sentiment. The February meeting, where new BoE forecasts will be presented, is widely seen as pivotal in shaping the central bank’s next steps.

In the meantime, the BoE’s gradual approach and measured tone are expected to persist, as policymakers navigate the complex dynamics of inflation, wage growth, and economic stability in uncertain times.

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