Rate Cuts Ahead: Positioning for the Bank of England's Shift in 2025

The UK economy is at a crossroads. With wage growth moderating, inflation cooling, and the Bank of England (BoE) balancing growth risks against lingering price pressures, the stage is set for an acceleration in rate cuts later this year. For investors, this presents a critical moment to recalibrate portfolios toward sectors poised to benefit from a dovish pivot. Let's dissect the data and implications.

Wage Growth: The Easing Tide

Recent data from the Office for National Statistics (ONS) reveals a clear deceleration in labor costs. In the three months to April 2025, annual regular wage growth slowed to 5.2% from 5.5% in the prior quarter—its lowest since late 2024. Real earnings, adjusted for inflation using CPIH, now grow at 1.4–1.5%, a significant moderation from earlier peaks. While sectors like construction and retail are still experiencing robust pay increases (5.9% and 7.7%, respectively), the private sector broadly faces a 0.4 percentage point decline in wage growth expectations. The public sector, buoyed by recent pay deals, has maintained stronger growth at 5.6%, though this too is moderating.

This slowdown is critical. Wage inflation has long been a key driver of broader price pressures. With the BoE's Decision Maker Panel forecasting further declines to 3.9% by early 2026, the risks of a self-reinforcing wage-price spiral are diminishing.

Inflation: Cooling but Persistent

The BoE's 2% inflation target remains distant, but the trajectory is now firmly downward. CPIH inflation averaged 3.7% in February–April 2025, a decline from the 2024 peak of 4.2%. Services inflation, once a stubborn obstacle, is easing, albeit slowly. The BoE's May policy meeting saw a 5-4 vote to cut rates, signaling internal recognition of the improving outlook.

Yet risks linger. Energy prices, driven by geopolitical tensions like the Israel-Iran conflict, could disrupt the path. Still, the BoE's May inflation report projects a return to target by end-2026—a timeline that hinges on sustained wage moderation.

The Case for Faster Rate Cuts

The BoE's gradual approach has been prudent, but the data now supports a more aggressive easing cycle. Consider three factors:
1. Wage dynamics: With the ONS's “Average Weekly Earnings” (AWE) showing declining momentum and the Decision Maker Panel's expectations pointing lower, the labor market's inflationary pressure is easing.
2. Global context: Central banks in the U.S. and eurozone are also pivoting toward dovishness, reducing the risk of capital flight from UK assets.
3. Growth risks: The OBR's downward revision of UK GDP growth to 1.0% in 2025 underscores the need for policy support to avoid a sharper slowdown.

The BoE's next move—likely a 25 basis point cut to 4.0% by year-end—could come sooner than markets expect if inflation continues to trend downward.

Implications for Investors

The path forward is clear: position for a falling rate environment.

Fixed-Income Assets: A Rebound Opportunity

Bond markets have underperformed in 2025 as the BoE's prolonged pause kept yields elevated. However, a shift toward rate cuts will reward bond investors. Short-term gilts (UK government bonds) are particularly attractive, as their prices are most sensitive to yield declines. The UK Gilts 1-3Y Index has lagged equities year-to-date but could outperform if yields drop to 3.5–3.7% by year-end.

Equities: Rotate to Rate-Sensitive Sectors

Equities will also benefit, but not all sectors equally. Utilities, real estate, and consumer discretionary stocks—historically tied to interest rates—are prime candidates:
- Utilities: Regulated companies like National Grid (NG) and Wales & West Utilities often thrive in low-rate environments, as their stable cash flows become more valuable.
- Real Estate: The UK's commercial and residential property sectors, which suffered under high borrowing costs, could rebound. The FTSE EPRA/NAREIT Index has underperformed the broader market but may see capital inflows.
- Consumer Discretionary: Lower rates reduce household borrowing costs, boosting spending on travel, autos, and home goods. John Lewis (part of the Tesco Group) and Next could gain, though sector-specific risks (e.g., online competition) remain.

Avoid overexposure to rate-sensitive cyclicals unless inflation stays anchored. Banks like Lloyds or Barclays may face margin pressure as the yield curve flattens.

Risks to Watch

• Energy Prices: A prolonged Israel-Iran conflict or supply disruptions could spike inflation, forcing the BoE to delay cuts.
• Wage Deal Risks: Public sector pay disputes, such as those in healthcare or education, could reignite wage pressures.
• Global Growth: A sharper-than-expected slowdown in the U.S. or EU could spill over into UK exports.

Conclusion: Act Now, but Stay Nimble

The data points to a BoE pivot by mid-2025. Investors should:
1. Increase allocations to short-term gilts to capture rising prices from falling yields.
2. Rotate into utilities, real estate, and consumer discretionary stocks, using dips in volatility to build positions.
3. Avoid overcommitting to rate-sensitive sectors without hedging against inflation shocks.

The UK's economic landscape is shifting. With the stars aligning for a dovish BoE, the time to position is now—but keep one eye on the horizon for geopolitical or wage-related surprises.