Bank of England forecast to cut interest rates amid rising unemployment and Trump tariffs

The Bank of England is widely expected to cut its benchmark interest rate by 0.25 percentage points to 4% on Thursday, the fifth reduction since last August, amid a contracting economy, rising unemployment (4.7%), and the impact of new global trade tariffs. While markets price in an over 80% chance of this move to stimulate growth, it underscores the UK's economic fragility and potential for stagflation, as June's 3.6% CPI inflation remains above the 2% target, with lingering food price pressures potentially leading to a split MPC vote.

Analysis

The Bank of England is confronting a significant policy dilemma, with financial markets pricing in an over 80% probability of a 25-basis-point interest rate cut to 4.0%. This widely anticipated move is a direct response to a deteriorating economic landscape, characterized by two consecutive months of contraction—a 0.3% decline in April and a 0.1% fall in May. The labor market is also showing clear signs of weakening, with the unemployment rate rising to 4.7%, its highest level since June 2021, and job vacancies falling below pre-pandemic levels. However, the decision is complicated by persistent inflationary pressures, as the June CPI of 3.6% remains well above the MPC's 2% target. A recent jump in food inflation is of particular concern as it directly impacts household inflation expectations. This combination of slowing growth and high inflation has elevated the risk of stagflation, a scenario underscored by the IMF's forecast for just 0.1% growth in the second half of the year. The situation is further compounded by external headwinds from new US import tariffs, which threaten global trade. A split vote on the MPC is expected, with hawkish members likely opposing a cut, signaling that the path for future monetary easing is uncertain and highly data-dependent.

Key Decisions for Investors

• Given that the 25bps rate cut is largely priced in, investors should focus on the MPC's forward guidance and vote split; a hawkish tone or a significant dissenting vote could temper expectations for further cuts and provide short-term support for sterling.
• The heightened risk of stagflation warrants a cautious stance on UK domestic-focused cyclicals and consumer discretionary stocks, as weak growth and persistent inflation are likely to erode corporate margins and consumer spending power.
• Monitor upcoming CPI data, particularly food and services inflation, as any upside surprises could challenge the Bank of England's easing path and introduce significant volatility for UK gilts and equities.