Key Takeaways
- UK inflation appears to have levelled off and upcoming data is expected to show an easing. Unemployment stands at a four-year high and wage inflation has slowed. A cut in UK borrowing costs seems likely in December.
- Expectations for a US rate cut have fallen from a 95% probability four weeks ago to a 45% chance now. Given uncertainties in economic data it seems likely that the hawks will prevail and that – in the absence of evidence for clear softening in the labour market – rates will remain on hold at the next meeting.
- Heading into 2026 and we will likely see a more dovish makeup of the Fed board so any market disappointment in December’s decision could be short lived as rates will likely be cut further next year.
- Rates around the world are not synchronised. The European Central Bank is on hold and the Bank of Japan will likely raise borrowing costs at some point. In the UK, a rate cut in December looks likely but the prospects of a reduction in the US are less clear.
This week we focus on the diverging chances of a rate cut in December from the Bank of England (BoE) and the Federal Reserve (Fed).
Recent economic data in the UK has moved expectations even higher that the BoE will cut interest rates while expectations in the US have gone the other way. Four weeks ago, expectations were of a 95% probability that the Fed would cut rates by 25 basis points in December but now that figure is down to 45% and certainly the language from the Fed members suggests significant uncertainty over what happens to rates next month.
Let’s think about what’s going on in the UK. We have had inflation data level off quickly and 3.8% looks set to be the peak with data published on Wednesday expected to show an easing to 3.4%. Obviously, that’s still way above the Bank’s target but the direction of travel is what’s important here and the BoE thinks inflation is going lower. Other data from the UK has increased expectations of a rate cut as well. Unemployment is now at a 4 year high of 5% and the wage growth data is also slowed. We have also had UK Q3 GDP numbers which were soft at 0.1% and indicative of an economy stuck in a rut. Last time round the BoE’s Monetary Policy Committee split 5 to 4 with Governor Andrew Bailey taking the view that they should hold for now but the language from Bailey and others suggests that they are minded to cut rates from here. When we look at economic prospects the Bank’s forecasts are very muted with next year’s growth of 1.2% and beyond that growth of 1.6% in 2027 and 1.8% in 2028. These figures are some way below the government’s own targets of 2.5% and hopefully the Budget next week will seek to address some of the issues. But expectations are that the Budget really won’t be inflationary – quite the opposite and that gives the Bank of England some room to manoeuvre.
Across the Atlantic things are different. Fed Chair Jay Powell after the last meeting made it very clear that a December rate cut was not a foregone conclusion and indeed the Fed appears split right now between the doves and hawks. For now it seems the hawks are winning in the sense that the majority of recent comments have suggested “there’s not enough data to warrant a cut”, the need to “proceed with caution” and “stay somewhat restrictive” and Jay Powell’s own comments about a December cut very much not being guaranteed have shifted the market mood in terms of what happens with rates next month. It’s also worth bearing in mind the blind spot in economic data. We will get the jobs report for September released this week, but the US government shutdown has left things a little foggy. That means we may not ever get an October inflation report and the jobs report for October also might be a little bit lacking terms of data quality so the Federal Reserve may well choose to wait and see and let the data settle down.
It seems like financial markets need a rate cut more than the US economy right now. The Fed will need to see more evidence of a softening in the labour market to justify cutting rates from here. What we’ve seen already is the Fed cutting rates pretty aggressively given the US is nowhere near a recession but it is worth noting that as we move into 2026 we are going to see a more dovish makeup of the Fed board so even if they don’t cut rates in December –which may cause some disappointment in markets – that doesn’t mean that they won’t cut further in 2026.
In summary, interest rates are not synchronised right now in terms of the policy path. Elsewhere the European Central Bank is on hold, while the Bank of Japan is set – at some point – to raise interest rates. The differing rate paths will create opportunities in some places but for the UK a December reduction now looks nailed on but for the US the prospects are less clear.
