Minister Saki Stalmer faces mounting political pressure over his handling of a scandal. Peter Mandelson's links to convicted sex offender Jeffrey Epstein. Well, let's get into some of this market direction as we gear up for the Bank of England decision. Simon French joins us, chief economist Panmure Liberum. I thought we would kick off talking about some of the inflation implications for the central bank as we wait for this decision. But it feels as though the gilt market is looking at other factors this morning. The political implications if we're talking about a change at Number 10. Just weigh in on that.
So I think you're right that gilts are really looking particularly at the long end of the curve on what might happen politically in the UK rather than in terms of monetary policy. And we've seen this morning yields move out on the 10-year up about seven basis points and up about 10 basis points since what was quite a crucial parliamentary question session for the prime minister yesterday. And that move took place at the time when treasuries and bonds have been flat. So it's quite an asymmetric UK move which tells you that investors are saying well we may see a leadership challenge come. I think most of us expect a leadership challenge in Q2. It may come as early as Q1 and the victor of that is likely to mean more issuance, more inflation, and how do we price that across the curve? We probably push yields higher.
We did see back end of last year the market had some dangling questions about the commitment to budget discipline under Rachel Reeves if there happened to be any change at Number 10. But do you think the Bank of England's actively going to be talking about some of this political situation at all today and implications?
Not this meeting, but roll forward three months to their next quarterly meeting when the market is pricing in the cut. The market isn't pricing in a cut today, but is pricing in a cut in Q2. That comes a week before the local elections in the UK. Normally a sort of fairly low-profile political event, but that could be the catalyst for political change. And so while I think the Bank of England probably get a bit of a free pass on talking about politics this time round, I think roll forward three months and they're going to be right in the crosshairs of what is potentially quite a different fiscal policy and political setup in the UK.
Well, let's just talk about price stability in the UK because that is what the central bank will be talking about. And in the back end of last year, we did actually see a pick up in some parts of inflation. Airfares, for instance, was one of the features. Market thinks it's going to slip back and we'll go back on trend in terms of seeing back at inflation. Is that necessarily the case? Do you have any concerns about price stability from here?
Oh, I definitely have concerns on price stability, but there's no doubt that actually inflation will come down from here and particularly in the crucial April print. April is always a really important print for the UK. Bit like for US investors, January is the important CPI print. For April, a lot of prices are indexed in April. We expect that to come down quite aggressively because the energy price cap which regulates household energy costs in the UK will come down about 100 pounds for the average household. But also some regulated prices. The chancellor, she made the finance minister here in the UK made interventions back at the November budget to lower those prices. So, we expect inflation to go down to 2.4% in the second quarter. My worries though are how sustainable is that move because those feel like one-off effects.
You make a point that you think UK monetary policy remains restrictive. How negative is it to have a restrictive backdrop on monetary policy when others are, like the ECB, for instance, are at neutral?
Well, it's inevitable if you haven't hit your inflation target, and you actually haven't hit your inflation target by quite a lot over the last 12 months. If you look at the bump in UK inflation in the middle part of 2025 as a result of tax changes, employer national insurance contributions were a big contributing factor. That meant that the Bank of England had to remain restrictive, couldn't go to neutral. Contrast that with price levels in the Euro zone where they're back sustainably on core measures and headline measures close to 2%. That means they can move to neutral. It's going to be a while, I think, before the MPC feel confident to move to neutral, which we think is about three and a quarter percent.
Something that hasn't dissipated anywhere is services inflation. I mean, even the ECB close to target later on today, they've still got a services inflation problem. We're seeing it in the UK as well. From hotels to airfares, what 4.5 to from 4.4 in November was the latest number we got. How that seems like it's still going to be one of those issues still to tackle. We'll park that there just for the minute because we're waiting for this decision to hit the tape. And of course when it comes to those expectations 3.75% is the rate and we are unchanged today as the decision has just hit the tape. The split here, the 7-2 split is what the market has been looking for. As you can see the ultimate reaction on markets today is that we have had sterling declining. We're 6.2% down at this rate. Just get a couple of lines here in terms of what's just crossed. The policy makers Breeden, Dhingra, Ramsden, and Taylor voted to cut rates by 0.25 percentage points to 3.5%. So in terms of that split, there has been five unchanged, four voting for a cut. So a 5-4 change is what we've now seen in terms of that voting split versus the 7 to 2 anticipated. Before I get to any other lines, Simon, do you want to weigh in on that?
Yes, surprised that Sarah Breeden and Dave Ramsden, the two deputy governors, voted alongside. We knew that Swati Dhingra and Alan Taylor would vote for a cut. For it to be so close to 5-4, I think the reaction of sterling be going a bit softer is likely to if you like crystallize the idea that the Bank of England will cut in this, you know, in the spring. Timing of that whether it's the April 30th MPC or into June, I'm not quite sure, but I certainly think that was a more dovish stance in terms of the vote setup than the market was expecting.
Yeah, we're just going to throw a couple more lines and feel free to jump in at any point. Andrew Bailey saying, 'All is going well. There should be scope for some further reduction in the bank rate this year.' Says does not mean I expect a cut bank rate at any particular meeting. So again clarity on the timing that it's still up in the air. He expects the CPI to fall to around 2% in spring. Need to ensure it stays there so that it's anchored. CPI to return to 2% target on a calendar quarter basis in the third quarter 2026. November forecast we're saying second quarter 2027. Is that significant as we're talking about a pull forward in terms of that?
It is. Look, it's a big monetary policy report which we'll have to work through but the headline on that is actually that it hits the inflation target in Q3 which is somewhat earlier. Now I'd be interested to see there have been a couple of conditional assumptions that have moved around quite a long way since the Bank last forecasted. Gas prices, although they've spiked quite a lot in recent days actually came down for most of the last quarter so that's a disinflationary impulse. Also sterling, although it's down on the day is actually strengthened certainly against the dollar and strengthened on a trade-weighted index that mutes imported inflation as well. And it feels like just looking at those headlines that the Bank of England will have factored that into its forecasting model and come up with hitting its target somewhat earlier. Hence perhaps what moved those two deputy governors to move to a rate cut vote rather than holding.
Yeah. A couple more lines here. The Bank of England monetary policy report risk of greater inflation persistence has become less pronounced. And when it comes to the MPR saying some downward inflation risk from weaker demand and looser labor market remain. When it comes to the labor market, one of the biggest features has been AI. The market is looking at how disruptive that could be. A lot of the labor market recruitment experts are saying look there are cyclical factors that you're seeing a lot of economies that's impacting the labor market. It's not necessarily AI at this stage. But earlier this week we had the very disruptive impact of Anthropic. The market was saying look that could just be a precursor to some sort of massive wave across the jobs market in terms of disruption. Do you think how are you thinking about the labor market and whether it could be upended this year?
So I tend to agree with what you're hearing from the recruitment sector which is what we're hearing as well from the listed recruitment sector which is for now it's national living wage, employer national insurance, the employee rights bill. These are legislative and tax burdens on employers that are meaning they've shed labor since really the middle part of 2024 and that is driving the UK employment rate lower and the unemployment rate higher. Now you're absolutely right on a medium long-term basis the big threat here is disruption and structural unemployment from obsolete skills but to see it in the data right now we haven't seen in the productivity data we haven't seen in the unemployment data. It might be the future story but let's be honest the central banks, the Bank of England included, are guessing like the rest of us on how disruptive that will be to labor supply matchup.
Yeah, let me just dig out some of the actual CPI numbers. The BOE forecast shows CPI in one year's time at 1.7%. A November forecast just to remind the audience was 2.5%. So that would take us below the 2% target effectively at 1.7% in a year's time. In two years time at 1.8% again below the November forecast of 2%. So at 1.8% below target again in two years time. In three years time at 2% versus 2.1%. So now we're talking in the near vicinity of one and two years time frame that we will be below target of 2%. Yeah. What does that suggest in terms of a rate cutting cycle?
It suggests that I think markets can firm up the idea of this being a year of rate cuts and probably the two or one and a half that was priced in before today and probably two by the end of today I would suspect based on this report is right. But going further would mean effectively saying that there such an output gap has grown that we actually not don't need to go to neutral but we probably need to come to quite an accommodative stance. That would be quite a damning verdict, quite a difficult one politically for the government to absorb for the Bank of England to say, 'Look, you've made such a mess of the growth agenda that we're having to move monetary policy to an accommodative stance because actually growth is so soft in the private sector.' The flying ointment here is PMIs and we had the construction PMI out first thing this morning from the UK. Another beat after the manufacturing and service PMI actually the cyclic indicators are turning upwards. So, is it possible that the bank are underestimating underlying resilience of demand? I think that inflation forecast may suggest they are. There's been a lot of excuses about the growth profile and whether some of that's been emanating from offshore tariff policy, uncertainty, macro events, geopolitics, every excuse for pretty much every leader including for the UK. And the UK would say, look, we did a ton of trade deals and that's been positive. On the growth forecast though, we're now for 2026 at 0.9 of a percent. That has been shuffled down from 1.2% in these forecasts. When it comes to next year, 1.5 versus the 1.6% that we're at. And by 2028 1.9 versus 1.8%. So you point around lower growth than just rounding out the employment side for some of these forecasts. Q4 of 2025 5.1% Q4 of 26 5.3% Q4 of 2027 5.3%. So those are the adjustments that we're working with. On the growth side, how disappointing is it when you know we're talking about the politics of the day, we're talking about an economy that badly needs growth in a huge technology transition.
What do you make of the growth?
Well, 0.9% is a pretty poor rate of growth. It's a less than half the average the UK has had over the last 30 years, but it is consistent with a really sluggish recovery since the end of the pandemic. Some pretty big cost headwinds as it happens. We're a bit more optimistic than the bank. We think one and a half percent growth. And actually, if you look at the UK, it has shown remarkable resilience. The consensus from independent forecasters, including the Bank of England, each December prior to the year ahead, has underestimated growth in 2022, 2023, 2024, and 2025. Will it do it again in 2026 because consensus is around 1%. I think it will. That's not a celebration of public policy. It's just a celebration actually resilience of UK businesses given everything that is thrown at them. They manage managed to still churn out growth. But it's what could be if we sorted out our capital markets, our energy markets, and our labor markets, which feel like some quite costly burdens on getting to what the government targets, which is the fastest sustained rate of growth in the G7.
It's a long wish list on that agenda you just threw at me. Thank you so much for helping me out. It's been eventful for what was expected to be a fairly quiet decision today. There was a lot happening. Simon, thank you so much. Simon French with us, chief economist at Panmure Liberum. Well, let's get out to Rita with more from the Bank of England. Rita, the vote split, the adjustments to growth, CPI, weigh in.
Yeah, well, I've been pouring through the details, of course, Karen, during the lock-in. As expected, the MPC voting to hold rates steady at 3.75%. That was as expected. What was more interesting, though, was the divide that we saw on the committee. We're expecting to have a 7 to 2 vote in favor of holding. We actually got a 5 to 4 split. So much more narrow than expecting again suggesting the divide on the committee. Now on balance the committee does see the risk of greater inflation persistence is less pronounced and that the bank rate is likely to be reduced further. Where they differ is both the timing and the extent of those cuts. Now, while they see inflation returning to the 2% target by April this year, in part helped by measures of the budget, there is caution around the sustainability of the return to 2%. And of course, key to that puzzle is the wage growth as well. Now, of course, they are weighing up the inflation outlook with the weaker demand side, the weaker labor market. That's the other side of the equation. And they see growth as you were talking about slowing to 0.9% by year end and unemployment rising to 5.3%. Also a savings ratio jumping to 9.3% by year end. There were no changes Karen on the overall guidance still suggest rates on a gradual downward path but again it goes back to the timing and the extent of those cuts.
We have seen an interesting move on the gilt market in the wake of the decision. So Bailey almost leaning against Mandelson. We had a Mandelson spike on the gilt market this morning that look the blowback for Saki Stalmer could be big enough to see him removed from Number 10 in terms of his handling of the situation but that rise that we saw the 10-year this morning has been counteracted by what is almost a dovish tilt in some quarters of this forecasting from the Bank of England. Do you want to just pick up on that and some of the political story how it's been assessed by the central bank?
