The Bank of England has kept interest rates unchanged at 3.75%, with underlying productivity growth concerns influencing policymakers’ assessment of sustainable economic performance. Productivity determines how fast the economy can grow without generating inflation.
The monetary policy committee’s 5-4 vote reflected awareness that weak productivity growth constrains the UK’s inflation-free growth potential. If productivity grows slowly, the economy can’t expand rapidly without creating labor shortages and wage pressures that fuel inflation. This limits how much monetary stimulus is appropriate.
UK productivity growth has been disappointing for years, a challenge predating recent inflation episodes. When productivity stagnates, living standards can rise only through inflation or unemployment. Higher employer costs from increased national insurance contributions may further discourage productivity-enhancing investment, worsening the problem.
The GDP growth forecast of 0.9% partly reflects weak productivity trends. If productivity were growing robustly, the economy could expand faster without inflation risks, potentially justifying more aggressive rate cuts. Slow productivity means even modest growth might generate inflation pressures.
Governor Andrew Bailey’s projection that inflation will fall to around 2% by spring assumes the economy can handle current demand levels without overheating. This depends on productivity growth being sufficient to meet demand. If productivity disappoints, supply constraints could prevent the expected inflation decline. The unemployment forecast of 5.3% suggests the labor market will have some slack. Chancellor Rachel Reeves’s budget measures, including utility bill cuts and rail fare freezes from April, don’t directly address productivity but ease cost pressures. The inflation forecast of 2.1% by mid-2026 incorporates assumptions about productivity evolving at historical modest rates.
