The Bank of England has reduced interest rates by 0.25 percentage points to 4.75%, marking its second rate cut of the year. The move aims to ease pressure on households and businesses struggling with high borrowing costs.
However, the central bank also issued a cautionary message: mortgage borrowers should not expect rapid rate cuts in the near future, as inflationary pressures are set to persist due to the government’s fiscal policies.
Inflationary Impact of the Government’s Budget
In its announcement, the Bank of England’s Monetary Policy Committee (MPC) signaled concerns about the economic implications of Chancellor Rachel Reeves’s latest budget.
The Bank stated that the £70 billion in additional government spending, coupled with higher taxes and borrowing, would drive inflation to new heights. Specifically, the Bank warned that these measures could increase headline inflation by up to 0.5 percentage points by mid-2025, and also contribute to a 0.75% rise in Gross Domestic Product (GDP).
The MPC’s decision was reached with an 8-1 majority, with one member, external economist Catherine Mann, voting to keep interest rates at 5%.
While the rate cut will provide some relief, the Bank revised its inflation forecast, expecting it to peak at 2.75% by mid-2025, slightly higher than its previous projection of 2%. It also predicted inflation would remain above its 2% target well into 2026 before starting to fall back in 2027.
Gradual Rate Cuts in the Face of Ongoing Inflationary Risks
Despite the rate cut, the Bank’s guidance suggests that future cuts will be slower and more gradual than previously anticipated. The markets reacted by adjusting expectations for interest rate movements, betting that the Bank would cut rates fewer times and at a slower pace over the coming year.
Paul Dales, chief UK economist at Capital Economics, stated that the Bank now appears on track to reduce rates to around 3.5% by early 2026, rather than the 3% previously expected. He highlighted that the government’s budget could lead to a longer, slower path to rate reductions.
Inflation Risks from Government Spending Measures
The Bank of England also expressed concerns about specific measures in the budget, such as the increase in employer National Insurance contributions (NICs) and the rise in the national living wage.
These moves could add to inflationary pressures if businesses pass on the additional costs through higher prices or lower wage increases. Other budget measures, including increased bus fares and VAT on private schools, could also contribute to rising costs for consumers.
Sarah Coles, head of personal finance at Hargreaves Lansdown, warned that the slower pace of rate cuts would be a blow for households already facing higher living costs. “The fact so few cuts are expected in 2025 will be a blow for anyone who was hoping for their mortgage to be less of a burden in the coming months,” she said.
Governor Bailey’s Cautious Outlook
Bank of England Governor Andrew Bailey provided a measured outlook, emphasizing the need for caution in rate cuts to ensure inflation stays close to the target. “We need to make sure inflation stays close to target, so we can’t cut interest rates too quickly or by too much,” Bailey said.
He also cautioned that global economic uncertainty, including potential trade disruptions and inflationary pressures tied to global events, such as the potential economic impact of a Donald Trump US election victory, could complicate the Bank’s policy stance.
Bailey also pointed to the risks of trade fragmentation and greater uncertainty in the global economy. “There is greater global uncertainty, without a doubt,” he noted. “We do have to watch very carefully the fragmentation of the world economy. There are a lot of risks attached.”
A Mixed Outlook for Households
The interest rate cut offers some relief to households, especially those with variable-rate mortgages, but it is clear that inflationary pressures are expected to persist.
While the Bank’s decision to lower rates to 4.75% is a positive step, the broader economic context, coupled with government policies aimed at stimulating growth, suggests that mortgage borrowers and consumers will continue to face challenges in the months ahead.
Rachel Reeves, the Chancellor, welcomed the interest rate cut as “welcome news” for millions of families. However, she acknowledged the ongoing challenges, particularly those stemming from the previous government’s economic policies. “This government’s first budget has set out how we are taking the long-term decisions to fix the foundations to deliver change by investing in the NHS and rebuilding Britain, while ensuring working people don’t face higher taxes in their payslips,” Reeves said.
As the economy adjusts to these new fiscal and monetary conditions, it will be crucial for both policymakers and households to stay prepared for the potential long-term effects on inflation and interest rates. The Bank of England’s cautious stance signals that while borrowing costs may fall, the journey to lower rates will be slower and more uncertain than many had hoped.
