The UK economy is currently navigating a period of uncertainty, with inflation rates causing significant concern among financial leadersA recent analysis from a team of economists at Bloomberg Economics forecasts that the Bank of England is likely to reduce borrowing costs five more times before confronting the potential for an overheating economy and rising inflation ratesThese experts suggest that, by the year 2025, the central bank may implement rate cuts on four occasions, followed by possibly just one in 2026.

Dan Hanson, Chief UK Economist at Bloomberg Economics, led the team that released these predictionsThey estimate that the so-called 'neutral interest rate' for the Bank of England will settle between 3% and 4%, a figure that significantly surpasses earlier expectations from the institution itselfThe midpoint of this range—1.25 percentage points lower than the current benchmark rate—serves as the proposed baseline for where interest rates will eventually stabilize.

As the Bank of England seeks to ensure a "soft landing" for the economy, recovering from the tumultuous inflation spikes of 2022 and 2023, it becomes essential to determine a monetary policy framework that neither stifles economic growth nor allows for excessive overheating

Following the most aggressive cycle of interest rate hikes in decades—aimed at curbing inflation that reached historical heights above 11%—the central bank is now on a path to reassess its monetary strategies.

The extent of potential future rate cuts from the Bank of England appears to be modest at bestRecent comments from Governor Andrew Bailey indicate that he anticipates the possibility of four rate cuts in 2025, each at a 25 basis point reduction, as opposed to the market's hope for a more considerable 50 basis point reduction in any given meetingThis scenario could see rates drop from the current 4.75% to 3.75%. However, he did refrain from providing specific figures regarding the neutral rate, mentioning only that it would be considerably higher than the near-zero levels observed from 2009 to 2021.

The economic team led by Hanson asserts that the space for the Bank of England to enact further cuts without triggering inflation seems severely restricted

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Their outlook for 2026 reflects only a single rate cut statement from the Bank that underscores a significant attenuation from earlier expectations of a neutral rate settling around 3%. In their view, the central bank's leeway for another substantial cut diminishes dramatically following 2025.

Furthermore, economists like Hanson note that as global central banks proceed with their rate-cutting, discussions concerning the conclusion of the monetary easing cycle are likely to intensifyThis ongoing conversation follows modeling efforts from major players like the European Central Bank and the Federal Reserve, both of which suggest that the neutral rate will shift in response to evolving inflation expectations, consumer confidence, and an array of economic indicatorsContrarily, the Bank of England has not revisited this subject since 2018, where it last projected a neutral rate range of 2% to 3%.

Last month, the Bank's Deputy Governor, Clare Lombardelli, commented that the neutral rate is “unobservable”, indicating the challenges in pinning it down accurately, a sentiment echoed by critics who argue that the Bank must express clearer opinions on the timing of interest rate reductions

Former rate-setter, Jethro Frew, criticized the Bank for stifling robust debate on this topic.

In a recent interview, the most dovish member of the Monetary Policy Committee, Swati Dhundra, suggested that the neutral rate has indeed shifted upwards, now estimated between 2.5% and 3.5%. Conversely, the most hawkish committee member, Catherine Mann, posits that the neutral rate has risen significantly, signaling that the prevailing monetary policy may not be as restrictive as previously thought.

Earlier this year, Charles Goodhart, a founding member of the Policy Committee, proposed that the long-term neutral rate might hover just above 4%. The team led by Hanson employed a model akin to that used by the Federal Reserve, revealing Britain's remarkable economic resilience amidst a rapid increase in the benchmark rate from a mere 0.1% to 5.25% in just 20 months.

One of the operational insights derived from the aggressive rate-hiking phase of 2022 and 2023 is that the UK economy has proven to withstand higher borrowing costs better than most models predicted