The Bank of England’s main policy rate, or Bank Rate, is expected to peak at 4.25 per cent in mid-2027, according to the latest forecasts. This projection comes from the Office for Budget Responsibility (OBR) and aligns with estimates from academic economist Costas Milas, who uses a monetary policy rule to model the BoE’s interest rate decisions. The neutral interest rate, which indicates a balanced monetary policy, is estimated to be between 2 per cent and 4 per cent. Currently, the Bank Rate stands at 4 per cent, nearing the upper bound of the neutral rate, suggesting a restrictive monetary policy.
The BoE’s policy is influenced by factors such as inflation expectations and the output gap. Milas’s model incorporates the BoE’s five-quarter and six-quarter ahead inflation expectations, as well as the OBR’s measure of the output gap. When inflation expectations exceed the 2 per cent target or output surpasses equilibrium, interest rates rise. The model shows that the Bank Rate has been below the neutral band from 2016 to 2021, briefly entered the neutral range, and then tightened significantly from mid-2022 due to rising inflation.
However, predictions are uncertain due to the increasing frequency and magnitude of economic shocks. Events like the global financial crisis, Brexit, COVID-19, and geopolitical conflicts have made forecasting more challenging. Additionally, US monetary policy decisions impact the UK, with a 100 basis point tightening by the Federal Reserve potentially reducing UK GDP by 0.5 per cent over three years. The unpredictability of President Donald Trump’s actions further complicates forecasts, making even the most sophisticated models unreliable.
In the worst-case scenario, the Bank Rate could rise to 4.6 per cent in mid-2027 if UK inflation remains high at 4.2 per cent in early 2028. This would indicate persistent inflation pressures, possibly due to additional shocks or wage-driven second-round effects. Despite these uncertainties, the OBR’s central forecast remains a peak of 4.25 per cent by mid-2027, with a slight increase to 4.4 per cent by early 2028.