The Bank of England’s decision to hold interest rates at 4.25% may have been widely expected, but that doesn’t make it right.
With unemployment rising, growth fading and inflation falling, the case for a pre-emptive rate cut was compelling. Yet the Monetary Policy Committee (MPC) has again chosen inaction.
This might be defensible if Britain were in the midst of a robust recovery, but it isn’t. Labour’s tax-raising Budget, combined with a sharp increase in public borrowing and spending, is already sapping confidence. Fiscal policy is amplifying the slowdown rather than offsetting it. If monetary policy stays restrictive, the result will be a pincer movement – squeezing households and choking businesses.
The data ought to prompt urgency. Retail sales fell 2.7% in May. Unemployment has risen to 4.6% – the highest since 2021. Payroll numbers dropped by 109,000, the steepest fall since the Covid pandemic. Output contracted 0.3% in April. And the outlook is worsening: the OBR expects just 1.0% GDP growth in 2025, with the IMF and OECD offering little better at 1.1% and 1.3%.
Meanwhile, broad money growth – long ignored by the Bank, but still a key signal of future demand – has slowed. Private sector wage growth is slowing, albeit still above the Bank’s comfort zone. And inflation, the MPC’s justification for delay, has fallen sharply from its 11.1% peak in 2022. Even services inflation – the stickiest component – is beginning to ease.
This is not an overheating economy. It is one showing clear signs of slack – and still waiting for the Bank to act.
The longer the MPC delays, the greater the risk that a measured adjustment turns into a painful correction.
The Bank’s decision to wait – with six members voting to hold – was framed, once again, as a matter of caution. Better to be sure inflation is ‘sustainably’ on target before acting. But at some point, caution hardens into inertia. And on this, the Bank has form. In 2021, it clung to the view that inflation was ‘transitory’ and delayed action for too long. That error helped trigger the cost-of-living crisis and badly damaged the Conservatives’ reputation for economic competence.
Now, the Bank risks repeating the same mistake in reverse – keeping policy too tight, for too long, even as the real economy falters. This has consequences – for households, for government and for the political system as a whole.
The Bank’s operational independence, granted in 1997, rests on a clear bargain: political autonomy in return for getting the big calls right. But when the Bank fails – repeatedly and visibly – trust erodes. And when that happens, change becomes not just possible, but inevitable.
That pressure is already growing. Reform UK has proposed rewriting the Bank’s mandate, including scrapping interest on reserves and giving growth equal status with inflation. Liz Truss continues to push for a supply-side monetary framework that recognises output, investment and productivity. These arguments, once dismissed as fringe, are moving into the mainstream.
This isn’t just a British trend. In the United States, Donald Trump launched a characteristically blunt attack this week on Federal Reserve Chair Jay Powell:
Jay Powell is a ‘real dummy’ who has cost our country trillions. Rates should be cut by at least 2.5% – and I would have nominated myself if I thought he’d stay this clueless.
Nobody is calling for such language here. But the message is clear: when central banks and governments drift apart in their economic diagnosis, confrontation is never far behind.
This tension matters most for Labour. The Chancellor has already committed to higher taxes and a significant increase in departmental spending. That means fiscal room is limited. If monetary policy stays too tight and the economy weakens further, Rachel Reeves may soon find herself forced to retrench. Austerity 2.0 – not driven by ideology, but by monetary miscalculation – could become the accidental outcome. And just as the Bank’s misreading of inflation helped bring down the last government, its failure to act now could end up undermining this one.
And yet, Threadneedle Street shows little urgency.
The Bank of England is no longer a purely technocratic institution. Central banks have become some of the most powerful actors in modern democracies – shaping borrowing costs, house prices, credit generation, inequality and fiscal sustainability. Since quantitative easing began, the idea that they operate above politics has been a convenient fiction. That fiction is now wearing thin.
None of this means abandoning price stability, per se. But nor should the Bank’s rigid 2% inflation target – enshrined in the 1998 Act – be treated as a form of economic scripture. A mature monetary framework must account for the real economy: output, employment, productivity and debt dynamics. And that means recognising when inflation is not demand-led but largely supply-driven and temporary.
Other central banks have already made that shift. The Federal Reserve has a dual mandate: maximum employment and price stability. New Zealand and Canada have introduced greater flexibility. The UK remains governed by a framework designed for a different era.
There are alternatives. In a recent paper for the Institute of Economic Affairs, I argued that nominal GDP targeting could offer a better balance – anchoring expectations while giving policymakers the tools to respond to shocks more intelligently. But even within the current system, the case for a cut is clear.
The MPC meets again in August. Markets are pricing in a modest 25 basis point cut. If it doesn’t come – despite weakening output and growing labour market slack – it won’t just be another policy mistake. It will be further proof that the Bank of England is not only behind the curve, but out of touch with the economic and political reality it was built to serve.
Because when monetary policy fails, it is not just economic recovery that suffers. It is the legitimacy of the institutions at the heart of our system.
