Bond Watch: rates cut and growth outlook slashed

Welcome to interactive investor’s ‘Bond Watch’ series, covering the latest market and economic news – as well as analysis – that is relevant to bond investors.      

Our goal is to make the notoriously complicated world of bond investing simpler, by analysing the week’s most important news and distilling it into a short, useful and accessible article for DIY investors.           

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New inflation target

The Bank of England (BoE) cut interest rates this week, as markets expected, by 0.25 percentage points to 4.5%. Two members preferred a 0.5 percentage point reduction in the Bank Rate, to 4.25%, while seven voted for the 0.25 point move. 

The BoE said there had been substantial progress on disinflation over the past two years and therefore it could ease interest rates while “maintaining the Bank Rate in restrictive territory so as to continue to squeeze out persistent inflationary pressures”. 

Despite the good news, the Monetary Policy Committee (MPC) said that due to recent developments in global energy costs and regulated prices, CPI inflation was expected to rise quite sharply in the near term, to 3.7%. It now expects inflation to finally fall back to its 2% target in the final months of 2027, six months later than its previous forecast.  

Fortunately, the MPC thinks this will not lead to additional second-round effects on underlying domestic inflationary pressures. 

• UK interest rates cut to 4.5%, but should it have been more?
• Bond Watch: US may not cut rates this year

The bond market reaction was subdued, with gilt yields not moving much following the announcement.  

Vivek Paul, UK chief investment strategist at BlackRock, said that recent data showed progress on inflation, with services inflation falling sharply from 5% to 4.4% in November. 

“The fight against inflation is not over and uncertainty around tariffs on various countries could push up global yields. So, we expect further rate cuts this year but at a measured pace,” he added.  

BlackRock is overweight gilts and believes that multiple further interest rate cuts are likely.  

“On balance, we think that makes current yields broadly reasonable relative to where we think they'll be in five years - although we watch for the risk of embedded stagflation,” Paul said.  

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Another takeaway from the BoE’s decision this week was that the MPC was worried about economic growth in the UK. It warned that the UK probably contracted by 0.1% in the final three months of last year. 

It now expects the economy to grow just 0.75% this year, down from its previous forecast of 1.5%.  

Slower growth boosts the case for greater interest rate cuts, which could be good news for bond prices.