Looser Fed policy stance could slow further rate cuts, policymakers warn

Growing divergence between US and UK monetary policy could increase inflation risks in Britain and complicate the path of interest rate cuts, a Bank of England policymaker has warned.

The US Federal Reserve cutting rates more aggressively than expected could impact UK inflation and the Monetary Policy Committee's path for interest rates, MPC member Megan Greene says.

The Bank of England currently expects headline inflation to fall back towards its 2% target in the second quarter of the year, quicker than had been forecast before the Budget.

Markets currently expect both the US Federal Reserve and the Bank of England to cut interest rates this year, while the European Central Bank is widely expected to keep rates on hold. However, investors increasingly see a higher probability that the Fed could ease policy more aggressively than currently priced in.

In a speech given at the Resolution Foundation, Greene says that if the Fed were to deliver unexpected rate cuts, this would probably increase inflationary pressures in the UK, which would strengthen the case for the MPC to withdraw monetary policy restraint more slowly than markets currently expect. Rather than rushing to cut rates, she argues that UK policymakers may need to remain cautious to ensure inflation is fully under control.

Surprise Fed rate cuts would likely lower global bond yields, including UK gilt yields, and support equity markets. That would loosen financial conditions in the UK, making borrowing cheaper for households and firms and potentially stimulating demand. Studies suggest such shocks typically lead to stronger UK growth and higher inflation.

Markets are already pricing in a significant risk of looser US policy next year. If that were to materialise, it would likely add to UK inflationary pressures and strengthen the case for caution at the Bank of England.

The implication is that even if UK inflation continues to fall in the short term, the MPC may be forced to move more slowly than investors expect when it comes to cutting interest rates. Policymakers appear increasingly wary that global financial conditions — led by the Fed — could undermine efforts to bring inflation fully under control.

Greene said UK policymakers cannot influence overseas central banks and should not set policy based on speculation about what others might do. Instead, she says, the focus should be on how foreign policy decisions affect UK economic conditions — especially inflation, growth and financial markets.

She commented: "The markets are currently pricing in a large risk of a looser Fed policy stance in 2026. If this were to materialise, then it would — all else equal — push up on UK inflation. This would, in my view, give even greater cause for concern about a risk of UK inflation persistence over that of weaker demand, warranting a slower withdrawal of monetary policy restriction in the UK."