Bank of England Governor Signals Potential for Greater Interest Rate Cuts as UK Economy Slows

The pound has fallen to a three-week low following comments from the Bank of England governor, Andrew Bailey, about the possibility of larger interest rate cuts if the UK jobs market deteriorates rapidly. Speaking to The Times, Bailey highlighted that economic “slack” is emerging, driven by higher taxes that are placing pressure on employers. He remarked, “I really do believe the path is downward” regarding future interest rates.

The central bank’s base interest rate currently stands at 4.25%, following four consecutive quarter-point cuts over the past year. With the next policy decision scheduled for 7 August, investors now see an 85% chance of another rate cut, up from 76% just last week. Bailey noted that rising taxes had prompted businesses to adjust employment, pay levels, and working hours. This reflects the economic strain caused by the £25 billion hike in employer national insurance contributions implemented in April, as well as a 6.7% increase in the national living wage.

Despite recent reductions in inflation, which dropped marginally to 3.4% in May from 3.5% the previous month, the figure remains well above the Bank’s 2% target. Bailey acknowledged concerns about rate cuts while inflation remains high, but expressed confidence in a downward trajectory for both inflation and interest rates. His comments had an immediate impact on currency markets, with the pound slipping 0.2% to $1.3467 before recovering slightly to $1.3474 later in the day.

The UK economy is also showing signs of broader weakness. Official data revealed a 0.1% contraction in GDP during May, following a 0.3% decline in April. Sectors such as manufacturing and construction have seen notable slowdowns, contributing to mounting pressure on the government to improve economic conditions amid stagnant growth forecasts and challenges to living standards.

Chancellor Rachel Reeves has been criticised for her fiscal measures, which included an unprecedented £40 billion tax hike in her October budget. While attempting to adhere to strict fiscal rules, Reeves’s plans have created only a narrow £10 billion buffer. This margin was quickly depleted earlier this year by U-turns on disability benefits and energy allowances, leading to expectations of further tax increases in her upcoming autumn budget.

The hiring landscape reflects these broader economic challenges, with a recent study by KPMG showing the sharpest drop in recruitment activity in nearly two years. Employers appear to be cautious amid weaker growth prospects, as labour market data now suggests rising staff availability and subdued wage growth.