The Bank of England is expected to cut interest rates much faster than financial markets are currently anticipating, according to new forecasts from Goldman Sachs.
The Wall Street investment bank expects the UK policy rate to fall to 2.75% by November 2025, driven by continued progress in the fight against inflation and dovish signals from policymakers.
At present, the UK base interest rate is 5%, which Goldman Sachs described as “remarkably restrictive”. Investment bank researchers believe the Bank of England will cut interest rates more aggressively than markets are pricing in, as inflation continues to decline. In contrast, the market consensus points to a slower decline, with interest rates expected to stabilize at around 3.5%.
Differing views on lowering interest rates
Goldman Sachs’ forecasts are in line with those of Deutsche Bank, which also expects faster-than-expected cuts, albeit at a slower pace. Deutsche Bank expects the base interest rate to fall to 3% by February 2026. Meanwhile, financial markets are currently anticipating two 25 basis point cuts by the Bank of England in November and December this year, bringing the base interest rate down to 4.5%.
The forecast follows a faster-than-expected decline in UK inflation, which fell to an annual rate of 1.7% in September from 2.2% in August. This has increased expectations that the Bank of England will ease monetary policy, although views within the bank’s Monetary Policy Committee differ on how quickly to act.
Andrew Bailey, the bank’s governor, suggested the Monetary Policy Committee could be more aggressive in cutting interest rates if inflation stabilizes, while Hugh Bell, the bank’s chief economist, favored a more gradual approach. The committee’s upcoming discussions at the IMF meetings in Washington are expected to provide more insights into the bank’s strategy.
Balancing economic pressures
The challenge for policymakers is to determine a “neutral interest rate” – a rate that neither stimulates nor restricts economic activity. Goldman Sachs estimates the UK neutral interest rate at 2.75%, up from the negative real interest rates seen in the wake of the global financial crisis. After accounting for inflation, they estimate the neutral real interest rate to be around 0.8%, which is in line with historical averages.
However, determining this rate is complex. The UK economy faces a unique mix of factors, including slowing productivity growth, rising public debt, and an aging population, all of which affect the long-term economic potential. The country’s debt-to-GDP ratio has risen from 35% in 2007 to nearly 100%, its highest level since the 1960s, putting further pressure on the economy.
In addition, Chancellor Rachel Reeves is expected to increase borrowing in the upcoming autumn Budget to fund public investment, a move analysts believe is unlikely to cause the kind of market instability sparked by former Prime Minister Liz Truss’s tax cuts last year. Reeves’ approach is expected to focus on investments that can boost long-term growth, rather than short-term financial giveaways.
Uncertainty about neutral interest rates
Central bankers often use estimates of the neutral interest rate to guide monetary policy, but these estimates are subject to a great deal of uncertainty. A miscalculation could lead to interest rates that are too high, constraining economic growth, or too low, stoking inflation. Goldman Sachs noted that while the Bank of England has indicated a neutral interest rate of approximately 2-2.5%, it remains cautious about giving too much weight to this estimate.
As the Bank of England navigates these uncertainties, the debate over how quickly to cut interest rates will be shaped by evolving economic data, especially inflation trends and global economic conditions. With interest rates likely to fall to 2.75% next year, businesses and consumers alike will be watching closely to see how the Bank of England responds to the changing economic landscape.