What Pythagoras’ theorem can teach us about the Fed

The BoE’s MPC voted on 07 August to cut Bank Rate by 25 basis points to 4.0%. The decision was widely anticipated by markets. However, minutes from the meeting reflected the divergence among MPC members over their assessment of economic data.

Although MPC members agreed there has been a substantial progress on bringing down inflation closer to the 2% target over the last two and a half years, the split vote reflects the differences in how policymakers interpret recent data and where the risks to inflation lie.

UK activity has been weak, which has been consistent with the loosening in the labour market. This has offset the strong growth in the first quarter of 2025, which was attributed to domestic front-loading ahead of expected rises in taxes and international trade tariffs.

The arguments behind the decision
The Committee was initially split in three ways, with four members voting to maintain Bank Rate at 4.25%, four members voting to cut Bank Rate by 25 basis points and one member voting to cut Bank Rate by 50 basis points. A second round of voting was required to secure a majority decision. This time the motion was limited to either maintaining Bank Rate unchanged or reduce it by 25 basis points. The latter was then supported by five members. This was the first time, since the MPC was formed in June 1997 that a second round of voting was required to reach a majority.¹

Minutes from the meeting highlighted the deceleration in services prices since the peak in 2023 and the softening in wage growth over the last months, although to different degrees. Data shows that headline Consumer Price Index (CPI) inflation accelerated to 3.6% year-on-year (YoY) in June from 3.4% YoY in May. However, services inflation remained elevated at 4.7% YoY. BoE’s estimates show that over half a percent of the rise in services prices can be attributed to administered prices, in particular vehicles excise duties.²  

Therefore, to assess the developments of underlying service inflation we constructed a measure of services inflation that exclude components such as administered prices, indexed and volatile components, rents and foreign holidays. For simplicity, we have called this series Underlying Services, see Chart 1.³

Chart 1 – UK goods and services inflation (year-on-year % change)

Source: LSEG Data & Analytics, ONS and EFGAM. Data as of 07 August 2025.

Underlying services inflation have fallen at a faster pace than for overall services prices over the last year, and now stands at 3.8% YoY. Although it has stabilised since the start of 2025, the disinflation since the peak of 7.2% in May 2023 remains significant. This has also been noted by MPC members in the August 2025 Monetary Policy Report (MPR), supporting the decision to cut rates at this point.

Nevertheless, the MPC’s projections for inflation have been revised upwards, with headline inflation expected to peak at 4.0% YoY in September, up from a projection of 3.75% YoY at the May MPR.

Chart 2 – Wage growth continues to decelerate

Source: LSEG Data & Analytics and EFGAM. Data as of 08 August 2025.

Although the inflation data leaves room for interpretation, wage developments have been more straightforward. Pay growth has decelerated to 4.5% YoY in May from over 6% YoY at the end of 2024, see Chart 2. As noted by BoE officials, part of this is attributed to fading base effects that had pushed up wage growth at the end of last year. Additionally, pay growth is expected to moderate significantly further in the second half of this year, with BoE data pointing to 3.5%-4.0% YoY in Q4. However, Committee members assessed that despite the anticipated rise in headline inflation in the coming months could affect price-setting behaviour, the weakness in labour markets means wages are bound to remain unaffected.

Labour market conditions have weakened in 2025, reflecting the deceleration in UK economic activity. Survey data from the BoE shows that additional weakness reflects the rise in employment costs, associated with the increase in employer National Insurance Contributions and the National Living Wage. Payroll data from HMRC, a good proxy for employment growth, has been in continuous decline since August 2024. Additionally, the vacancies-to-unemployment ratio, a measure of labour market tightness has declined below the equilibrium level estimated by the BoE, see Chart 3.⁴

Chart 3 – Vacancies-to-Unemployment ratio suggest a loosening labour market

Source: LSEG Data & Analytics, Bank of England, Bank Underground and EFGAM. Data as of 8 August 2025.

Conclusion
The MPC’s decision to cut rates by 25 basis points was widely anticipated by markets. However, the narrow vote among Committee members was a surprise, reflecting the challenges faced by policymakers at the BoE. BoE Governor Andrew Bailey reiterated at a press conference after the meeting the need to maintain a cautious and gradual approach for reducing Bank Rate. Risks to inflation have shifted upwards, highlighting the need to maintain a restrictive-enough policy. According to data from the MPR, the real interest rate gap with the neutral real rate shows that monetary policy remains tight in the UK, although the impact of this tightness on activity may have passed its peak.

The more hawkish tone from the MPC also suggests that monetary policy is not on a pre-defined path. Additionally, this implies that in the absence of significant progress on inflation in the coming months, the pace at which the committee will reduce Bank Rate going forward might be even slower. Expectations are currently set for rates to remain on hold at the next meeting on 18 September. This could also be reinforced by the fact that the Chancellor’s Autumn Budget will likely be announced in late October and could see changes to the UK’s tax regime and reforms that would affect prices. Therefore, the next rate cut might not come before the last quarter of 2025.

¹ In February 1998 and March 1998, the MPC still had only eight members, and a tie was recorded at both meetings. In those instances, Governor Mervyn King exercised his casting vote to reach a decision. A ninth member was appointed from the June 1998 meeting.
² Bank of England, Monetary Policy Report, August 2025. https://www.bankofengland.co.uk/-/media/boe/files/monetary-policy-report/2025/august/monetary-policy-report-august-2025.pdf
³ The components of this series account for roughly half of the headline CPI index. 
⁴ https://bankunderground.co.uk/2025/03/06/what-can-40-years-of-data-on-vacancy-advertising-costs-tell-us-about-labour-market-equilibrium/