Britain’s ‘knife-edged’ economy is dividing BoE rate-setters

Rate-setters at the Bank of England are finding their job increasingly difficult.

In its most recent meeting, the bank’s monetary policy committee (MPC) made the decision by the thinnest of margins. Four members wanted to lower rates by 25 basis points, another four preferred to hold, and one voted for a half-point cut. Governor Andrew Bailey called a second round of voting to settle the difference, and the MPC ultimately went for a 25bp cut, ignoring the position of the BoE’s two top experts on monetary policy.

This was the first time ever the committee had to vote twice to reach a rate decision. It highlights the different views among MPC members on where the UK economy is headed, as changes in prices and growth move in opposite direction. While still some way away from the stagflationary environment in the 1970s, policy-makers today face an economy more susceptible to supply shocks, complicating monetary policy.

A feature not a bug

Jonathan Haskel, a former MPC member at the BoE from 2018 to 2024, sees no issues in the rift among the current rate-setters.

“Disagreement is good,” Haskel, who returned to Imperial College London following his stint at the bank, tells Central Banking. “The whole point about disagreement is that it is a feature, not a bug … there’s no point in having a nine-person committee if just one person decides.”

This feature was already present when the MPC was in its infancy in the late 1990s, adds John Vickers, a professor at the University of Oxford and an MPC member from 1998 to 2000.

“We had extremely vigorous debates, and I felt no sense that I was being disloyal or anything of that kind,” he says. “I just voted for the policy that I thought was the best policy.”

The BoE’s decision-making process on the policy rate is often viewed as less consensus-driven than that of other major central banks, as MPC members regularly dissent from the majority. By contrast, no member of the board of governors at the US Federal Reserve had dissented between 2005 and 2024.

“We always voted as nine individuals,” says Charlie Bean, professor emeritus at the London School of Economics (LSE) and an MPC member from 2000 to 2014. “Unlike the Fed or [the European Central Bank], there is no ‘stitch-up’ ahead of the meeting by some inner caucus.”

However, disagreement on the scale of August’s meeting is still rare. In that decision, Clare Lombardelli, deputy governor for monetary policy, and Huw Pill, the chief economist, voted to hold, thus being outvoted by the majority.

The last time both MPC members in these two positions were voted down dates to July 2007, when Bean, the then bank’s chief economist, alongside Rachel Lomax, the deputy governor for monetary policy at the time, voted to lower rates against the majority.

Disagreement is good … there’s no point in having a nine-person committee if just one person decides

Jonathan Haskel, Imperial College London

Observers question whether Bailey had sufficient reason to overlook the arguments presented by his two most senior monetary policy experts on the committee.

“Why do you employ a deputy governor for monetary policy and a chief economist and then ignore them?” asks Paul Mortimer-Lee, a research fellow at the National Institute of Economic and Social Research (NIESR) and a former head of the BoE’s forecasting division.

Mortimer-Lee acknowledges the need to avoid excessive groupthink within the MPC and that members should have a variety of views. Nevertheless, he believes the bank should not have cut rates in August. “[The MPC] assumes the rise in inflation to 4% by September is not going to have any second-round effects – that’s hugely optimistic,” he argues.

Economy in opposite directions

Annual headline inflation in the UK was 3.6% in June, higher than the 3.4% the MPC had forecast in May. Prices are expected to hit 4% in September, before falling to 2.7% in the third quarter of 2026, according to the BoE’s August monetary policy report (MPR).

The MPC attributed the unexpected inflation overshoot to one-off increases in energy and food prices and employers’ tax. While it maintained its forecast that such price hikes would be temporary, it acknowledged “upside risks around medium-term inflationary pressures have moved slightly higher since May”.

At the same time, the committee judged a “margin of slack” had emerged in the UK economy. It added there was “significant uncertainty around estimates of the current degree of slack”.

“The committee is on a knife-edge,” says Imperial’s Haskel. “There is too much inflation and activity is very subdued. When the economy is on a knife-edge like that, the committee is bound to be split.

Slack refers to resources in the economy not used, such as machines left idle in a factory or people who cannot find a job. It lowers the cost of capital and labour and exerts disinflationary pressure.

Haskel points out that government policies such as increases in employers’ tax and the minimum wage have made measuring slack difficult, as it becomes unclear how well firms can reduce prices or cut labour cost.

The minimum wage and tax hikes both came into effect in April this year. In the August MPR, the BoE said these measures have likely pushed up services inflation, which stood at 4.7% in June.

Haskel says if he were still on the MPC, he would be one of the members who believes there is not a lot of slack in the economy currently.

If I was still on the committee, I would probably be in the hawkish camp right now

Charlie Bean, London School of Economics

The LSE’s Bean notes that domestically generated inflation, especially unit labour cost growth, is running at least a percentage point higher than target-consistent levels, which necessitates a period of slack to squeeze prices back to target.

“It is unsurprising that views on the committee presently differ,” he says. “If I was still on the committee, I would probably be in the hawkish camp right now.”

Policy-making under fiscal uncertainty

Towards the end of the press conference following August’s cut, Bailey was asked for his views on how next year’s minimum wage rise – which the UK’s Low Pay Commission had proposed increasing by 4.1% – would affect inflation.

“We take into account announced policy – and that obviously is not announced policy yet,” he responded. “I don’t think it’s appropriate for us to offer any judgement on what that [the minimum wage] should be because, frankly, it’s a public policy decision.”

Some parties believe that if the MPC can only make decisions based on announced fiscal policies it may be less forward-looking – its August MPR was based on the government’s spending plan announced in the Spring Statement, which was made in March.

The situation is made more challenging given the UK’s erratic fiscal restructuring, as the ruling Labour Party tries to push through spending reforms. In July, chancellor Rachel Reeves had to reverse welfare cuts after facing opposition from within her own party.

Instead, the MPC can factor in fiscal developments by looking at a set of forward-looking indicators, suggests Imperial’s Haskel. These include metrics such as consumer confidence, savings rates, business sentiment and job vacancies.

“If the economy is forming expectations about fiscal policy, then the fiscal policy would show up potentially in those indicators,” Haskel says. “The governor is right to say, ‘can’t make policy on what we expect to happen’, but there is a feed-through mechanism by which this is effectively accounted for.”

The Treasury and the gilt market

Like many advanced-economy central banks, the BoE’s balance sheet has grown significantly since the global financial crisis, as years of quantitative easing have piled up assets on its book. This has complicated monetary policy.

“When I was involved – and before the financial crisis of 2008 – it was literally a one-dimensional job: you pick the interest rate,” says Oxford University’s Vickers. “Whereas when you have this huge balance sheet expansion, you’ve got other variables in play.”

The UK Treasury indemnifies the BoE’s losses related to QE, which it began to incur in 2022. As interest rates rose, the bank started paying more on the reserves created to fund QE than the interest it receives on purchased assets. The scale of QE losses is highly dependent on where the policy rate is – the higher the rate, the larger the losses.

According to the bank’s most recent estimates, the Treasury will pay, net, around £115 billion ($155 billion) to the BoE on these losses, assuming the policy rate follows a ‘market path’. However, if the policy rate gradually falls to ‘the equilibrium rate’ instead, the net losses would only amount to around £55 billion.

Notwithstanding the QE losses, the bank’s ongoing quantitative tightening programme has increased the government’s cost of borrowing by pushing up yields of UK sovereign bonds, or gilts. Cumulative QT since February 2022 has increased 10-year gilt yields by 15–25bp, according to bank staff estimates.

The NIESR’s Mortimer-Lee suspects that Bailey, formerly head of prudential regulation, and Sarah Breeden, the current deputy governor for financial stability, voted to cut out of concern that a more hawkish decision could upset markets, drive gilt yields up and reduce the government’s already-limited fiscal headroom.

“My guess is they’re worried about financial stability,” he says. “There could be a lot of things we don’t know about, but certainly the gilt market seems to be on a tightrope.”

The August meeting minutes made no mention of the gilt market, and it is unlikely that the governor would ever publicly discuss how much or if any of the Treasury’s fiscal position influenced his decision-making. Nevertheless, Mortimer-Lee points to a trade-off between price and financial stability that the BoE – and many other central banks – face today as sovereign debt levels climb.

Following the historically close vote in August, Bailey told journalists that the 25bp cut was a “finely balanced” decision. With growth sluggish, inflation above targets and little sense of fiscal certainty from the government, the MPC may reach a few more finely balanced decisions moving forwards.