Bank of England to Hold Rates on Shocks From U.S. and Germany

Above: File image of Governor Andrew Bailey. Photo by Zara Farrar / HM Treasury.

"Seismic" changes from the U.S. to Germany will influence Bank of England thinking.

The Bank of England (BoE) is expected to hold interest rates at 4.50% next week, resisting further cuts as geopolitical uncertainty stemming from U.S. trade policy and a seismic shift in German fiscal strategy tightens financial conditions, according to Sandra Horsfield, economist at Investec.

At its March 20 meeting, the BoE's Monetary Policy Committee (MPC) is widely anticipated to pause its easing cycle, following a 25 basis-point rate cut in February.

While domestic economic data has been mixed, a surge in uncertainty linked to President Donald Trump’s trade actions and Germany’s unexpected ramp-up in defense spending has sent UK yields higher and the pound stronger, tightening financial conditions.

U.S.-Europe Turmoil Alters BoE’s Playbook

"The elephant in the room is international," Horsfield said in a note. "Since the last MPC announcement on February 6, President Trump has launched what looks to be only the first in a series of tariff rises, and his meeting with Ukrainian President Zelenskyy on February 28 has raised fears that Europe may no longer be able to count on U.S. security backing."

The uncertainty has sent shockwaves through European markets. In response, Germany’s incoming chancellor, Friedrich Merz, announced plans on March 3 to ramp up defense and infrastructure spending beyond the country’s constitutional debt brake, a move that could unleash a major fiscal stimulus.

"This would represent a huge fiscal expansion at both the national and EU level," Horsfield noted. "These are seismic changes the MPC will need to take into account."

Tighter Financial Conditions, Disinflationary Forces

While the direct impact of Trump's new steel and aluminum tariffs on the UK is expected to be limited - affecting roughly £2.9 billion (0.1% of GDP) in exports - the broader economic consequences could be more pronounced.

"The indirect effect will be larger," Horsfield said. "As other countries are hit and their demand shrinks, so will their appetite for UK exports."

Moreover, the heightened market volatility has driven up UK bond yields and strengthened the pound against the dollar, effectively tightening financial conditions - a disinflationary force that the BoE cannot ignore.

"For now, the BoE appears in no rush to react," Horsfield said. "Patience is a virtue here. The fog of uncertainty will clear somewhat with upcoming events, including the UK’s Spring Forecast and the U.S. announcement of reciprocal tariffs on April 2."

With inflation still at 3.0% as of January and some upside risks in the near term, the BoE is expected to maintain its gradual approach to rate cuts.

"We are not convinced the MPC will need to deviate from its current trajectory," Horsfield said, projecting three more 25bps rate cuts by year-end, bringing the Bank Rate to 3.75%.

But she cautioned that the outlook remains highly uncertain, particularly as geopolitical tensions escalate and global financial conditions evolve:

"As Keynes is often (mis)quoted: when the facts change, we reserve the right to change our minds."