The Bank of England has signalled it could start cutting interest rates as early as next month after inflation was found to be “moving in the right direction”, as it kept borrowing costs on hold at 5.25% for the sixth time in a row.

Alongside the decision to keep rates on hold, the Bank said inflation was already on course to hit its target of 2% and would fall to just 1.6% in two years, opening the door to future cuts in interest rates.

Giving a more upbeat assessment of the economic outlook than in its February report, the Bank also suggested the UK recession had ended, predicting the economy had grown 0.4% in the first three months of the year. The Office for National Statistics will publish the official estimate of growth on Friday.

The nine members of the Bank’s rate setting monetary policy committee were split on the decision to hold interest rates, with two members – Swati Dhingra and Dave Ramsden – voting for an immediate cut to 5%. Dhingra was the lone voice calling for a rate cut at the previous meeting of the MPC.

Andrew Bailey, the Bank’s governor, indicated that a rate cut next month was a possibility. “Before our next meeting in June, we will have two full sets of data – for inflation, activity and the labour market – that will help us in making that judgment afresh,” he said. “But, let me be clear, a change in bank rate in June is neither ruled out nor a fait accompli.”

The Bank said a modest economic turnaround was unlikely to be inflationary, leaving the UK on course for several rate cuts this year.

Financial markets have been pricing in two rate cuts this year, with the first expected in August.

Bailey said: “With the progress we’ve made, to make sure inflation stays around the target, it is likely that we’ll need to cut bank rates in the coming quarters, possibly more so than is currently priced into markets.”

A modest increase in unemployment over the next year is expected to lead to easing wage growth across the private sector, reducing the pressure on prices.

Bailey said the MPC voted to wait and see after a majority agreed there needed to be more evidence of inflationary pressures remaining subdued.

“We’ve had encouraging news on inflation and we think it will fall close to our 2% target in the next couple of months,” he said. “We need to see more evidence that inflation will stay low before we can cut interest rates. I’m optimistic that things are moving in the right direction.”

The rate-setting US Federal Reserve is also closely watching data for signs the American labour market is weakening. Figures from the US Labor Department on Thursday showed that new jobless benefit claims rose by 22,000 to 231,000 in the week to 4 May. It was the highest since last August, and much more than the rise to about 210,000 predicted by economists.

UK inflation fell to 3.2% in March, according to official figures, and is expected to have fallen to 2% in April after a reduction in the energy price cap.

The Bank said inflation would be bumpy this year with a rise towards an average of 2.5% in the second half of 2024, before falling again in 2025 and 2026 to 1.6%.

Increasing concerns that the conflict in the Middle East will widen and further disrupt shipping on major trade routes, raising prices, had so far been unfounded but remained a risk to the outlook, the Bank said in its latest report.

Suren Thiru, head of economics at the accountancy body ICAEW, said the vote to hold rates was a missed opportunity to provide much needed relief for “those people struggling with their mortgage bills and businesses facing numerous cost pressures”.

“Given the Bank is now forecasting inflation to fall more quickly, an interest rate cut by the end of the summer remains very much on the table,” he said,

Raj Badiani, an economist at S&P Global Market Intelligence, said the Bank’s tough stance “cast a dark shadow over the economy’s immediate recovery prospects”.

He said millions of UK households remain trapped in the cost of living crisis that was being extended by high interest rates staying in place for longer than necessary, pushing up mortgage and rent.

“The cost of living crisis is now being fuelled by spiralling housing costs, rising tax burden and historical high food and energy price levels,” he said.

• This article was amended on 21 May 2024 to correct Raj Badiani’s job title.