UK Monetary Policy Report May 2025
- Alexander Mitchell
- May 8
- 6 min read
Introduction
The UK economy in May 2025 remains in a state of transition, grappling with the cumulative effects of a series of major economic disruptions. The consequences of Brexit, the prolonged energy price crisis, and the residual economic scarring from the Covid-19 pandemic continue to weigh heavily on output and price stability. Against this backdrop, the Monetary Policy Committee (MPC) of the Bank of England faces the challenging task of balancing its dual mandate: ensuring price stability whilst also fostering sustainable economic growth. The Committee's recent decision to reduce the Bank Rate to 4.25% signals a cautious withdrawal of monetary tightening amid evidence of easing inflationary pressures, though risks remain in both directions. This report uses the Bank of England’s May 2025 Monetary Policy Report to assess the current macroeconomic environment, consider future prospects, and present policy recommendations to guide monetary strategy in the coming quarters.
Current Macroeconomic Climate
The economic situation in May 2025 is characterised by a mix of moderate growth and persistent inflationary pressures, stemming from global supply chain adjustments, robust consumer demand, and uncertain global trade developments. Whilst the headline indicators show a degree of economic resilience, underlying trends reveal fragility and imbalance.
The Consumer Price Index (CPI) for the year to April 2025 registered an increase of 3.1%, exceeding the Bank of England’s 2% target. This is a concerning figure, not simply because it is above the target, but because it reflects embedded inflationary pressures. The persistence of high energy costs – driven by volatile global energy markets and geopolitical tensions – continues to feed into consumer prices. Additionally, supply bottlenecks, particularly for intermediate goods used in manufacturing, have led to increased production costs, which firms have passed onto consumers.
This pass-through mechanism demonstrates a key inflation dynamic: when input prices rise, producers often raise their own prices to preserve profit margins. This can result in a feedback loop if consumers expect prices to continue rising and adjust their behaviour accordingly (e.g., by accelerating purchases or demanding higher wages). The fact that core inflation remains above historical norms despite easing energy prices indicates that such second-round effects are still at play.
Meanwhile, the UK economy experienced a quarterly growth rate of 0.4% in Q1 2025. Although this represents modest positive growth, it is significantly lower than the growth rates seen in late 2024, highlighting a deceleration in economic momentum. Several factors underpin this slowdown:
Business investment remains subdued, with firms hesitant to expand amid trade uncertainty, shifting tariff regimes, and higher employment costs stemming from increased National Insurance contributions.
Consumer spending is weakening. Households continue to adjust to higher inflation, which is eroding real incomes and forcing a shift toward essential expenditures. Discretionary spending, a critical driver of GDP, is being curtailed as the cost-of-living pressures persist.
The savings ratio increased notably to 11.6% in Q4 2024, the highest since the pandemic. This is an important behavioural signal: households, likely reacting to economic uncertainty and rising unemployment expectations, are choosing to save rather than spend. This shift further dampens aggregate demand, even as nominal incomes have begun to recover.
The labour market, a key economic indicator for inflation and economic capacity, has also shown signs of softening. The unemployment rate has increased to 4.6%, and vacancy-to-unemployment ratios have declined, indicating a loosening labour market. Private sector regular wage growth has fallen to 5.9% in the three months to February 2025, down from higher levels in 2024. This deceleration suggests easing domestic inflationary pressures but also highlights potential slack in the economy.
The Future: Slowing Momentum, Persistent Frictions, and Policy Uncertainty
The UK’s economic future is expected to be shaped by moderate growth, persistent geopolitical tensions, a gradual unwinding of inflation, and supply-side constraints that reflect a new era of slower productivity and labour market adjustment. The Bank of England’s central forecast suggests a short-term increase in inflation before a gradual return to target levels. However, this outlook depends on several interrelated factors.
The near-term rise in CPI inflation to a projected 3.5% in Q3 2025 is primarily driven by regulatory factors, including the reset of the Ofgem energy price cap and changes to regulated service prices. These are expected to lift headline inflation temporarily but, crucially, without triggering widespread second-round effects in wages and pricing behaviour. This contrasts with the inflation surge of 2021–2022, which was both broader and more persistent due to a tighter labour market and global supply shock convergence.
Beyond Q3, inflation is forecast to decline steadily, with CPI reaching 2.4% by mid-2026 and stabilising around 1.9% in 2027–28. This is conditional on the easing of domestic price pressures and a gradual build-up of economic slack. The Bank anticipates that the UK will experience a growing output gap – approaching 1% of potential GDP by late 2026 – due to tight fiscal policy, a still-restrictive monetary stance, and expected weak global demand.
Key Drivers of the future outlook include:
Monetary Policy Path: Market expectations imply Bank Rate will decline from 4.25% to just above 3.5% by 2026 Q2, signalling a slow return to neutral policy. Whilst this should support household and business activity, the timing and pace of easing remain data-dependent.
Productivity Trends: The UK’s potential productivity growth remains sluggish. Much of the recent stagnation cannot be explained by Brexit, Covid-19, or known cyclical factors, suggesting deeper structural weaknesses. If productivity fails to improve, output per worker will remain low, limiting real wage growth and capacity expansion.
Trade Frictions and Tariffs: Global trade tensions, notably those between the US and China, are feeding into UK trade outcomes. The imposition of tariffs and high trade uncertainty is expected to depress UK export growth and weigh on manufacturing sentiment. Import prices, however, may fall due to weak global demand, especially from China, and an appreciated sterling.
Labour Market Participation: The participation rate has stagnated at around 63%. An ageing workforce, long-term sickness, and post-pandemic structural shifts are contributing to a lower effective labour supply, which in turn may cap the economy’s potential growth unless addressed through reform or immigration policy.
Household Behaviour: The elevated savings ratio and more cautious consumer sentiment suggest that households may continue to limit discretionary spending. Though real incomes are rising again, the behavioural shift towards precautionary saving could delay a full recovery in domestic demand.
Energy Transition and Climate Costs: The move toward low-carbon technologies and net-zero targets continues to pose transitional inflation risks, particularly in regulated energy and transport sectors. These will need to be carefully managed to prevent inflation persistence whilst maintaining long-term investment incentives.
Looking ahead, the medium-term future is likely to be characterised by modest growth, gradually normalising inflation, and a continued need for cautious, responsive policymaking. Risks remain in both directions, but the broad trajectory suggests a shift away from crisis-era volatility toward a slower, more structurally constrained economic rhythm.
Policy Recommendations
Given the macroeconomic outlook, monetary policy must remain responsive, balanced, and evidence-driven. The MPC has rightly adopted a gradual easing approach, lowering the Bank Rate from 4.5% to 4.25% in May 2025. However, several considerations should guide future policy:
Maintain a Restrictive Stance in the Short Term: Whilst inflation is easing, it remains above target, and inflation expectations among households have recently risen. Maintaining Bank Rate at restrictive levels (i.e., above neutral) is essential to prevent inflation persistence. A premature return to neutral or accommodative policy could undermine recent progress.
Communicate Clearly on the Inflation Path: The MPC must continue to be transparent about its inflation outlook and the conditional nature of its decisions. Credible forward guidance will help anchor inflation expectations and reduce volatility in financial markets.
Monitor Labour Market Slack and Productivity: Labour market indicators suggest a modest loosening, but further deterioration could signal a deeper demand-side issue. Policymakers should closely watch productivity trends – currently weak and unexplained – as they have major implications for wage inflation and supply-side potential.
Be Prepared for Divergent Scenarios: The Bank’s alternative scenarios highlight the dual risks of either rapid disinflation due to demand weakness or renewed inflation persistence due to supply constraints and wage pressures. Policymakers must remain agile, using real-time data and surveys (such as the DMP and Agents’ reports) to detect which scenario is unfolding.
Coordinate with Fiscal Authorities Where Appropriate: The Spring Statement 2025 suggests a tightening fiscal stance. If fiscal drag proves stronger than expected, monetary policy may need to do less of the heavy lifting. Conversely, should fiscal policy turn expansionary (e.g., via public investment), the MPC must reassess the balance of macroeconomic stimuli.
Conclusion
The UK economy in 2025 continues to face significant challenges, from embedded inflationary pressures and a fragile growth outlook to heightened global uncertainty and domestic structural constraints. Inflation has fallen markedly from its 2022 peak, but remains above the Bank of England’s target, necessitating a continued restrictive monetary policy stance. The MPC’s recent interest rate cut to 4.25% reflects confidence in the direction of travel but not yet arrival at stability.
Looking ahead, the economic recovery will be shaped by the interaction of easing price pressures, a gradually loosening labour market, and potential productivity stagnation. Global trade developments, energy market volatility, and domestic fiscal policy will all play key roles. Monetary policy must remain flexible and vigilant, ready to pivot as the data evolve. The goal must remain clear: return inflation sustainably to target, support the economy's productive potential, and rebuild public and investor confidence in the UK’s macroeconomic framework.
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