Bank of England to Gift Reeves an Early Christmas Present

The Bank of England (BoE) is likely to deliver a Christmas interest rate cut following this week's budget.

The Bank will lower Bank Rate 25 basis points to 3.75% after judging that a number of measures in the budget will contribute to lower inflation in the coming months.

It will assess that lower rates can help stimulate a moribund economy, where data warns of rising unemployment.

The door was opened to the move by Chancellor Rachel Reeves, who on Wednesday revealed the government would help lower household energy bills by part-funding the renewables levy on energy bills.

Another measure included in her budget was an annual freeze in fuel duty, which will lower inflation by 0.3pp next year.

"There is some welcome good news that inflation will be helped by measures on energy bills, dampening it by just over 0.4% next year and theoretically raising the potential of more significant interest rate cuts," says Lindsay James, investment strategist at Quilter.

Money market pricing shows investors are now fully priced for a December cut, while the odds of follow-through reductions for 2026 have also risen.

Market bets for further easing in interest rates were lifted after the budget sought to raise an estimated £26.1BN in additional taxes by the end of the decade.

Tax hikes should squeeze demand, which naturally acts as a constraint on inflation, allowing 'easier' monetary policy at the Bank.

"This convinced investors that UK fiscal consolidation remains on track, and that tighter fiscal policy will help to reduce inflation in 2026. This will allow the Bank of England (BoE) to press on with two or three more 25bp rate cuts," says Andrew Wishart, UK Economist at Berenberg Bank.

However, government spending will also rise: in cash terms, analysts interpret the Budget as adding roughly £32BN per year to public spending relative to prior forecasts. 

This could prove inflationary, and some economists think the Bank of England might not be able to cut as far as some expect.

Savvas Savouri, the veteran economist, says the UK has entered a new phase in which inflation stays above 2.0%.

"We must accept that the UK’s CPI has moved for the foreseeable from an 'orbit' of 1-3% to one of say 2.5-4.5%. As to why, well, for all sorts of reasons; green-enviro policies, post-covid desires for supply-security, reshoring & higher inventories, inflation beating public sector pay & minimum wage awards, & so much else," he explains.

A higher orbit for the UK's inflation rate will constrain the Bank of England's ability to reduce interest rates to levels seen in the previous decade.

Given this, economists at ABN AMRO expect future interest rate cuts in the UK won't be deep.

"We think any flirtation with the BoE’s 2% target will prove short-lived and that inflation will move higher again in 2027. As such, following the likely front-loaded December cut and another cut in the first half of 2026, we see limited scope for the MPC to lower rates further," says ABN AMRO's FX Strategist Georgette Boele.