A View from the Bridge - December 2025

The Bank of England did its Dickensian best to keep the Ghost of Xmas Present onboard with a 25bp cut to 3.75% yesterday, but it remained true to its scrooge-like approach to signalling further interest rate cuts in 2026. Governor Bailey’s casting vote on a 5-4 vote split, caught some market participants by surprise, but the comments from each committee member were fairly consistent with their debut last month; the hawks expressing their reluctance to cut too quickly in the face of elevated wage pressures and structural shifts in the labour market, and the doves remain concerned about a soft growth outlook and rising unemployment/spare capacity.
It is important to recall that officials were not presented with new forecasts this month, the groundwork for a cut was laid at the November meeting with the bank wanting to see the economic implications of the Chancellor’s Budget (back-end loaded £26bn fiscal tightening) and further evidence of moderating inflation (CPI fell to 3.2% in November, 0.3% below their MPR forecast). Hence, if the market was genuinely concerned about a 5-4 vote split it would not have ascribed a 98% probability to a cut. There was a small knee jerk move higher in 6m to 2y rates on the vote headlines but this was starting to unwind by the close of business supported by softer US inflation data. The overnight SONIA rate is now 3.72%, with 2-year at 3.51% it’s therefore difficult to foresee the market moving too much in either direction until we get fresh data in the New Year (the next BOE meeting is on 5th February).
Heading into 2026 the Bank of England retains an easing bias, however more emphasis is now being placed on the proximity to neutral policy, which is also consistent with guidance from the US Federal Reserve (Fed Funds 3.625%) and European Central Bank (Refi rate 2.00%). For BOE officials this is the policy rate that has a “goldilocks” effect on the economy, supporting steady demand and supply growth and the 2% inflation target at the 2- to 3-year forecast horizon. That said, the best forecasters in the world will admit to flying blind as you can’t really know where neutral is until you have the ex-post outcomes of the policy setting. With inflation falling more quickly towards the 2% target and unemployment moving higher in recent months the BOE still need to avoid collective inertia or groupthink over neutrality. It’s important to remember that policy has been somewhat restrictive from a peak of 5.25% in August 2023 to 3.75% today, meaning that there may not be sufficient stimulus in the system to offset a further rise in unemployment in early 2026. Many things have changed in terms of the structure of the economy since COVID and the subsequent cost of living crisis, but it’s worth remembering that rates were on a gentle uphill path at 0.75% in late 2019. Therefore, our own confidence interval for neutral policy is somewhat wider than the building consensus.
Looking at the more immediate horizon we would expect some positive tailwinds heading into Q1 2026. There is little doubt that pre-budget mis-steps dampened consumer demand and investment growth in Q3 and Q4, so better growth data should lie ahead as the lagged effect of lower rates (globally) provide assistance. However, fiscal policy is no longer expansionary and the private sector will need to do more of the heavy lifting in the coming years. The government will be hoping for some good news after a tumultuous twelve months on various fronts, nonetheless political instability could return by the late spring.
To summarise recent comments by committee members, the central tendency is around 3.0-3.5%, or a further 0.25%-0.75% of base rate cuts. As you will know from our previous editions of VFTB, the term structure of rates is now very flat, meaning that the market accepts that we are moving closer to this hallowed policy setting, ascribing a near 50/50 probability of rates troughing at 3.25% or 3.5%.