The Bank of England cut its key interest rate by a quarter-point to 3.75 percent, saying that the U.K. economy had cooled enough to justify loosening financial conditions.

But after cutting rates in every quarter this year, it signalled that it is likely to slow the pace of easing in 2026, amid fears that inflation is still too far above target and that wage growth is set to remain stubbornly high, despite rising unemployment.

“We think that Bank Rate is likely to fall gradually further in future, but that will depend on whether variables like pay growth and services inflation continue to ease,” Governor Andrew Bailey said in a statement accompanying the Monetary Policy Committee’s decisions.

The move was widely expected after data earlier this week showed that unemployment had risen to its highest in over four years in October, while inflation slowed more sharply than forecast in November as supermarkets and other retailers found it harder to pass on price increases.

The cut was the fourth this year and the sixth since the Bank started cutting rates in 2024, as the post-pandemic wave of inflation began to ebb. It brings the U.K.’s key rate down to its lowest level in nearly three years and will immediately benefit businesses whose borrowing costs are largely floating. It’s also likely to bring down the key two-year government bond yield, to which most new mortgages in the country are closely linked. That rate has already fallen some 0.15 percentage points in the last week in anticipation of today’s move. 

As has been the case for most of the year, the MPC was deeply divided on how to balance the risks of a slowing economy with stubborn inflation, with Bailey once again casting the decisive fifth vote.  

The MPC voted 5-4 in favor of the move, with both Chief Economist Huw Pill and Deputy Governor for Monetary Policy Clare Lombardelli voting against a cut.  

The split was a little more ‘hawkish’ than many in financial markets had expected. Notably, neither of the MPC’s two most ‘dovish’ members proposed a bigger half-point cut. Accordingly, the pound rose against the dollar and the euro as participants trimmed expectations for further easing next year. 

Most members of the MPC acknowledged that Chancellor Rachel Reeves’ budget, unveiled last month, will have the opposite effect from her previous one. The MPC judged that, by removing various charges from customers’ energy bills and imposing freezes on a number of government-administered prices, the budget will cut headline inflation by as much as half a percentage point by the middle of next year. 

Together with the effects of economic weakness — the Bank assumes no growth in the final quarter of this year — it expects the budget to drive headline inflation down to 2 percent by the second quarter. 

However, even those who voted for a cut at the meeting expressed concern that it may not stay there for long, since forward-looking surveys on wages still suggest relatively strong pay growth next year.

“The budget should mechanically reduce annual inflation in salient categories, reducing the risk of second-round effects, but in absolute terms, underlying inflation is still well above target-consistent rates,” Lombardelli said in comments attached to the MPC statement.  They said they were unconvinced that the current interest rate level is actually holding the economy back at all anymore. 

At the other end of the spectrum, external MPC members Alan Taylor and Swati Dhingra voiced concern that the Bank risked hurting the economy unnecessarily by keeping policy too tight for too long. They both warned that the long time lags of monetary policy required action now, before the U.K. lurches into a recession. 

Taylor pointed to the sharp recent rise in youth unemployment, which he said should be taken as a sign of the economic cycle weakening. He estimated the neutral level for the Bank Rate at “about 3 percent” and said, “We should be heading there sooner rather than later.”

This article has been updated.