The Monetary Policy Committee's decision last month to hold the base rate at 4.5% was greeted in much of the financial press as a sign that Britain's long inflationary nightmare is drawing to a close. Governor Andrew Bailey struck a cautiously optimistic tone, pointing to falling energy prices and cooling wage growth as evidence that the Committee's aggressive tightening cycle — nine consecutive hikes between late 2021 and mid-2023 — had done its job.
But a closer look at the underlying data suggests the MPC may be declaring victory rather too early. Inflation is falling, yes. Whether it is durably falling is a different question entirely.
The Headline Numbers and What They Obscure
CPI inflation in the UK stood at 3.1% in February 2026, down sharply from its peak of 11.1% in October 2022. On the surface, this looks like a textbook disinflation — the kind of gradual, orderly decline that central bankers dream of achieving without tipping the economy into recession.
THE CHART GOES BELOW THIS
But headline CPI is a blunt instrument. Strip out volatile food and energy prices — the components most subject to external shocks beyond the MPC's control — and the picture looks considerably less benign. Core inflation, which excludes these components, remains at 3.7%. Services inflation, which the Bank watches most closely as a measure of domestically generated price pressure, is sitting at 4.8% — more than twice the 2% target.
Key figures: UK CPI February 2026: 3.1% · Core CPI: 3.7% · Services CPI: 4.8% · MPC target: 2.0% · Current base rate: 4.5%
This divergence between headline and services inflation is not a technical footnote. It is the central problem facing the MPC. The dramatic fall in headline CPI from its 2022 peak was driven overwhelmingly by the reversal of the energy price shock — global gas prices fell, the energy price cap came down, and the base effects from a year of extraordinarily high energy bills dropped out of the annual comparison. None of that has anything to do with monetary policy, and none of it tells us much about whether wage-driven, services-sector inflation is under control.
The Labour Market: Tighter Than It Looks
The Bank's modal forecast, published in the February Monetary Policy Report, assumes that wage growth will cool to around 3.5% by the end of 2026, consistent with the 2% inflation target given trend productivity growth of approximately 1.5%. This is an optimistic assumption.
Average weekly earnings growth, excluding bonuses, ran at 5.8% in the three months to January 2026. That figure has been remarkably sticky. It declined only modestly from its mid-2023 peak of 7.8%, and the pace of deceleration has slowed considerably since mid-2024.
The labour market, meanwhile, is softer than it was at the peak of the post-pandemic tightness, but it is far from loose. The unemployment rate rose from 3.5% in early 2023 to 4.6% today — a meaningful increase, but one that still leaves unemployment below most estimates of the structural rate. Job vacancies have fallen sharply from their record highs, but remain elevated relative to pre-pandemic norms.
The labour market is not broken. It is bruised. There is a difference, and it matters enormously for what happens next to wages — and therefore to inflation.
This matters because services inflation is, at its core, a labour cost story. Service sector businesses are relatively labour-intensive, and when wage growth is running at nearly 6%, it is very difficult to see how services inflation returns sustainably to levels consistent with 2% CPI. The arithmetic simply does not work unless productivity picks up sharply — and there is little evidence that it is doing so.
What the Market Is Pricing
Markets are currently pricing approximately three rate cuts of 25 basis points (bps) each by the end of 2026, which would take the base rate to 3.75%. This pricing has shifted considerably over the past three months: at the start of the year, markets were pricing only two cuts.
Basis points (bps): A basis point is one hundredth of one percentage point (0.01%). Central bank rate changes are conventionally described in basis points — a 25bps cut means a reduction of 0.25 percentage points.
The shift in market pricing reflects growing confidence that the disinflation trend will continue, combined with a softening in the growth outlook. The UK economy grew by only 0.1% in the final quarter of 2025, and the composite PMI — a forward-looking survey of business activity — has been hovering just above the 50 threshold that separates expansion from contraction.
But market pricing and MPC policy are not the same thing. The MPC has, on several recent occasions, pushed back against what it has characterised as overly aggressive easing expectations from financial markets. Bailey's post-meeting press conference last month contained a pointed reminder that the Committee would be "guided by the data, not by market expectations of where the data will go."
The Case for Patience
There is a credible case that the MPC is doing the right thing by holding. Monetary policy operates with long and variable lags — the standard estimate is that a rate change takes 18 to 24 months to have its full effect on inflation. This means the tightening delivered in 2022 and 2023 is still working its way through the system.
"Monetary policy is like steering a supertanker — by the time you can see the iceberg clearly, it is already too late to avoid it if you haven't started turning early."
On this view, the correct strategy is to hold rates at a level that is genuinely restrictive — most estimates put the "neutral" rate for the UK at somewhere between 2.5% and 3.5% — and wait for the lagged effects of past tightening to do their work. Cutting too early risks undoing the progress made so far, reigniting wage-price dynamics, and forcing an even more painful tightening cycle further down the road. The MPC remembers well what happened in the 1970s, when premature loosening allowed a second, worse inflation wave to develop.
The Case for Concern
The counterargument is that the MPC is already behind the curve in the other direction — that rates are too high for too long, and the cumulative drag on the economy will prove more severe than the Bank's models currently suggest.
There are real signs of stress in credit-sensitive sectors. The housing market has been subdued throughout the tightening cycle, with mortgage approvals running well below their pre-2022 average. Residential investment has fallen for seven consecutive quarters. Corporate insolvencies have been elevated, particularly among small and medium-sized enterprises (SMEs) that rely heavily on floating-rate bank lending.
The concern is not that these stresses will cause a financial crisis — the banking system is well-capitalised and resilient by historical standards. It is that they will compound to produce a sharper slowdown in demand than the Bank expects, driving inflation below target and forcing reactive, potentially destabilising rate cuts in 2027.
The Divergence Problem
One factor that complicates the MPC's task considerably is the divergence between UK monetary policy and that of the European Central Bank (ECB) and, to a lesser extent, the US Federal Reserve.
The ECB has cut aggressively, with the deposit rate now sitting at 2.0% — 250bps below the Bank of England's base rate. This differential has consequences for sterling. A stronger pound — which tends to follow from relatively higher UK interest rates — acts as a disinflationary force by reducing the cost of imports. To that extent, the BoE's caution on cuts has an automatic stabilising quality.
But there is a growth cost. A stronger currency makes UK exports less competitive, and a sluggish Eurozone economy — the UK's largest trading partner — is already a headwind. The combination creates a difficult balancing act.
Our Assessment
The MPC's hold decision is defensible. Services inflation at 4.8% is genuinely inconsistent with the 2% target, and cutting rates before it has clearly turned would risk undermining the credibility that the Bank has worked hard to rebuild after its initial misjudgement of the 2021–22 inflation surge.
But the confidence embedded in the Bank's own forecasts — that inflation returns to target by mid-2027 without a recession — requires a fairly precise set of circumstances to materialise. Wage growth needs to cool meaningfully in the next two to three quarters. Productivity needs to recover. Global commodity prices need to remain stable. Consumer spending, which has held up better than expected so far, needs to slow without collapsing.
Each of these is individually plausible. Together, they amount to a soft landing — and history suggests soft landings are rarer than central bank forecasts tend to imply.
Markets are pricing in a soft landing that history suggests is rarely so graceful.
The MPC may be right. But those expecting rate cuts to arrive quickly and cleanly should prepare themselves for a more complicated journey. The last mile of disinflation is rarely straightforward — and in the United Kingdom in 2026, there is little reason to think this time will be different.