The Bank of England has kept interest rates unchanged at 3.75%, with underlying debate about the “neutral rate”—the interest rate level that neither stimulates nor restricts the economy. Views on this theoretical construct influence policy positions.
The monetary policy committee’s 5-4 vote partly reflected different beliefs about where neutral rates lie. Members voting for cuts, like Alan Taylor who suggested 3% should be “in our sights,” implicitly believe neutral is below current rates, meaning policy is still restrictive. Those voting to hold may believe neutral is higher, meaning current rates are already appropriate.
The neutral rate isn’t directly observable but must be inferred from economic behavior. In an economy growing at potential with stable inflation, the prevailing rate is likely near neutral. With GDP growth forecast at just 0.9%—probably below potential—and unemployment rising to 5.3%, current rates may be above neutral, restricting activity.
However, inflation at 3.4%, still above the 2% target, suggests rates may not be restrictive enough, implying neutral could be higher than 3.75%. This creates genuine uncertainty about whether policy is already appropriately calibrated or needs further adjustment.
Governor Andrew Bailey’s indication that inflation will fall to around 2% by spring while growth remains weak suggests current rates are indeed restrictive, meaning neutral lies below 3.75%. If neutral is around 3%, as Taylor suggests, then significant further cuts are needed. Chancellor Rachel Reeves’s budget measures, including utility bill cuts and rail fare freezes from April, are expected to drive inflation to 2.1% by mid-2026, potentially below target, which would support the view that current rates are too restrictive and neutral is indeed lower.