The Bank of England is expected to swiftly reduce interest rates in the upcoming year, according to a forecast from Goldman Sachs.

Analysts at the prominent investment bank indicated that the UK’s base interest rate has risen to 2.75% since the onset of the Covid-19 pandemic, which is significantly higher than the negative real rates experienced during the decade following the global financial crisis. Once inflation is factored in, they assessed the current “neutral interest rate” to be approximately 0.8%, aligning with its historical average dating back to 1870.

Goldman Sachs emphasized that the current UK base rate of 5% is considered “notably restrictive” and predicted that the Bank of England will eventually reduce rates more than what financial markets have anticipated. This assessment is supported by ongoing disinflation and the recent dovish statements from the bank.

According to Goldman Sachs, they project sequential cuts leading to a terminal rate of 2.75% by November 2025, which is significantly lower than current market expectations.

In contrast, analysts at Deutsche Bank expressed a more conservative view, suggesting that the Bank of England will cut rates, but at a slower pace than Goldman Sachs predicts, with expectations of a base rate of 3% by February 2026.

While financial markets anticipate a relaxation of monetary policy in the next two meetings, there is a broader consensus that the base rate will stabilize around 3.5%, which is considerably higher than Goldman Sachs’s forecasts.

Recent data revealed that inflation has decreased more rapidly than the Bank of England had anticipated, with an annual rate falling to 1.7% in September from 2.2% in August. Notably, services inflation, an indicator of domestic price pressures that the Bank closely monitors, reduced from 5.6% to 4.9%.

Although Consumer Price Index (CPI) inflation is expected to rebound in the latter part of the year due to increases in the energy price cap, market traders still foresee a 25 basis point reduction in rates at the upcoming November and December meetings, reducing the base rate to 4.5%.

Discussions among members of the Bank of England’s monetary policy committee (MPC) are varied regarding the persistent inflation and the pace of rate reductions. Governor Andrew Bailey suggested that more aggressive actions could be warranted if data shows inflation has stabilized, while Chief Economist Huw Pill advocates for a more gradual approach.

Bailey, along with other MPC members, is scheduled to participate in panel discussions with global finance ministers at the International Monetary Fund (IMF) in Washington this week, where their comments may offer insights into the future course of monetary policy.

Goldman Sachs pointed out that several factors, such as stagnant productivity growth, declining capital goods prices, and an ageing population, are likely to continue suppressing neutral interest rates in the UK. Conversely, rising public debt and increased population growth may counteract this trend.

The debt-to-GDP ratio in the UK has surged from approximately 35% in 2007 to nearly 100%, marking the highest level since the 1960s. Meanwhile, productivity’s contribution to overall GDP growth has diminished considerably during this time, impacting the economy’s fundamental resilience.

Chancellor Rachel Reeves is expected to announce increased borrowing during the budget on October 30 to enhance public investment spending. Analysts believe that funding through borrowing for investment is unlikely to result in a turbulent bond market like that which followed former Prime Minister Liz Truss’s tax cuts.

Policymakers typically reference the neutral interest rate, which is designed to neither stimulate excessive growth nor inhibit economic activity, as a guide.

Determining the accurate neutral interest rate is challenging due to the ever-changing behaviors of consumers and businesses, leading to the possibility of central banks setting borrowing costs too high or too low based on uncertain estimates.

Goldman Sachs reiterated that the uncertainty surrounding these neutral rate estimates is substantial, aligning with the Bank of England’s cautious approach to heavily relying on these figures in policy decisions.

The Bank of England estimates the neutral interest rate for the UK to be between 2% and 2.5%.