By Laurence Hulse, lead manager, Onward Opportunities trust

While it is expected that the Bank of England’s Monetary Policy Committee will vote to hold the base rate at 3.75% for February, we remain convinced that UK growth will be modest, and interest rates will continue to fall through the year.

The question now is about timing; how far and how fast will we see rate cuts and what does that mean for UK small caps? 

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Against a soggy domestic economic backdrop, some of the global drivers of inflation are easing. Energy prices and key agricultural inputs have already come off their peaks, and the base effects here will become more favourable as we move through 2026. ‘Truflation’ prints both here and in the US have fallen well below 2% now and are a live statistic that they calculate privately using lots digital inputs.

Continued weak consumer demand will not just limit the ability of firms to raise prices; it will also force management teams to focus more aggressively on employment costs. In practice, we expect ongoing headcount reductions and a clear shift in bargaining power away from labour and back towards employers. This matters because services inflation, which has been stuck at 4–5% year-on-year, is heavily wage-driven.

More slack in the system and softer labour costs are the key ingredients for that measure to roll over decisively. As a result, the unemployment rate is likely to remain on an upward trend, with the latest data showing the biggest monthly drop in PAYE employment figures since November 2020.  

When we put all of this together, we see a clear and plausible path for UK CPI to fall from around 3.4% in December 2025 to roughly 2.0% within 12 months for the first time in five years. To us, this still feels underappreciated. 

If inflation falls as quickly as we expect, the central bank’s priorities will pivot towards stabilising employment and supporting a recovery in demand. We therefore still believe rates could fall to 3% by the summer. In that environment, we would expect the Bank to continue cutting the rate by around 25 basis points per quarter until it reaches roughly 3.0% by the summer. 

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Lower rates are likely to help stimulate a rebound in GDP, ease pressure on heavily indebted households and SMEs, while driving flows out of cash and fixed income into equities. 

The Bank of England, and large parts of the market, are behaving as though the last mile of disinflation will be persistently sticky. Our read of both macro and micro data is that the drivers of that stickiness are themselves now fading. 

If we are right, the conversation will move quite quickly from “how high for how long?” to “are we behind the curve on the way down?”. 

A 50bp larger cumulative reduction in Bank Rate than investors currently expect would also be felt in the bond market. We estimate this could pull 10‑year gilt yields down from around 4.5% to well below 4% by the end of 2026, easing the government’s debt-servicing costs and providing some fiscal breathing room. 

Most importantly for our universe, UK small-caps are typically geared to falling rates. They benefit disproportionately from lower financing costs, are more sensitive to domestic demand and often sit outside mainstream benchmarks. 

So, while bad news for the UK economy continues to dominate in 2026, this could prove to be good news by its end.