Bank of England holds off on rate cut after Fed goes big

While it opted to stand pat, the U.K.’s central bank said that it is likely to follow up on an August cut over coming months in anticipation of a decline in inflation to its 2% target late next year, but also said it is concerned by the still-rapid pace at which services prices and wages are rising.

The Fed Wednesday lowered the federal-funds rate for the first time since March 2020, by half a percentage point. Officials signaled that they are likely to cut the key rate again in coming meetings as worries about inflation ease and concerns about the jobs market grow.

But the BOE all but ruled out a move of that size or a quick succession of smaller cuts.

“We should be able to reduce rates gradually over time," said Gov. Andrew Bailey. “But it’s vital that inflation stays low, so we need to be careful not to cut too fast or by too much."

The Fed’s decision to trim rates by a larger amount than most analysts anticipated until just a few days ago is a fresh challenge for the BOE and other central banks that have signaled a more gradual approach.

Responding to the changed outlook for interest rates, the British pound has appreciated against the U.S. dollar over recent weeks. Any further increases will add to downward pressure on inflation by lowering the prices of many imports, but will also make it more difficult for Britain’s exporters—including its large tourist industry—to sell to U.S. customers.

While eight of the BOE’s nine rate setters voted to leave borrowing costs unchanged, a record of their meeting said that most favored further rate cuts, albeit at a cautious pace. Before the rate announcement, investors expected the BOE’s next move to come in November. The BOE noted that the November meeting would involve “a full assessment of recent and prospective developments" as new forecasts become available.

Norway’s central bank also left its key rate unchanged Thursday and said it won’t cut this year. Coupled with the BOE’s decision, that is a sign that many European policymakers are less convinced they have tamed inflation than their U.S. counterparts. Taiwan’s central bank also stayed pat Thursday.

Brazil has already seen a revival in inflation after a series of rate cuts that ended in May and its central bank decided to raise its key rate just hours after the Fed’s move. Most policymakers would want to avoid that kind of volatility in borrowing costs, which can make it difficult for households and businesses to make financial plans.

Although the U.K.’s headline inflation rate is close to the BOE’s target, its policymakers are unsure whether it will settle there. Some fear that a still-tight jobs market will keep pushing wages sharply higher, pressuring businesses in labor-intensive sectors to raise their prices at such a rate that inflation remains above target for many months.

To counter that outcome, BOE policymakers said the key rate will have to be high enough to dampen demand for some time to come. But there are signs that high borrowing costs are taking a heavy toll on the economy, which stalled in June and July after a surprisingly strong start to the year. The BOE said it expects growth to resume but at a weaker pace.

Weaker oil prices will likely reinforce the impact of the stronger pound in reducing some prices, suggesting policymakers may have less cause to worry about inflation than they did just a few months ago.

The BOE also set a 100 billion pound target—equivalent to around $132 billion—for reducing the size of its bond portfolio in the year through September 2025. The bonds were acquired through the quantitative easing programs the BOE undertook in an effort to boost the economy and safeguard the financial system between 2009 and 2021.

The BOE began to reduce its bond portfolio as inflation surged in 2022. But unlike other leading central banks, it has done so partly through sales of bonds, rather than waiting until they mature. Since bond prices have fallen in recent years as interest rates have risen, the BOE makes a loss on the sales, which has to be paid for by the U.K. government and therefore adds to its debts.

But while the BOE’s target for quantitative tightening is unchanged in the coming year, a larger share will be completed by letting bonds mature and only £13 billion will be carried out through sales, reducing the government’s losses.

Write to Paul Hannon at paul.hannon@wsj.com