Interest rates cut to 3.75% but further reductions to be 'closer call'

Interest rates have been cut to 3.75%, the lowest level in nearly three years, after the Bank of England warned that the economy is stalling.

Policymakers voted 5-4 in favour of the cut in a "knife-edge" decision, driven by concerns over rising unemployment and weaker economic growth. While the Bank indicated that rates are expected to decline further, it warned that decisions on future cuts next year would be a "closer call."

"We still think rates are on a downward trend, but with every cut we make, [it becomes a question of] how much further we go," said Bank Governor Andrew Bailey.

Inflation and the Budget 📉

The decision to lower borrowing costs from 4% was widely anticipated after data released this week showed inflation had slowed to 3.2% in the year to November.

Following the government's tax and spending measures in last month's Budget—and falling oil and gas prices—the Bank now expects inflation to fall "closer to 2%," its target, by the spring or summer of next year. Previously, it did not expect to reach this target until 2027.

Chancellor Rachel Reeves recently announced that the government would cut £150 off household electricity bills and freeze fuel duty and rail fares, helping to ease price pressures.

A "Lacklustre" Economy

Despite the rate cut, the Bank painted a gloomy picture of the immediate economic landscape, noting that growth had flatlined in November and was expected to remain at zero for the final months of the year.

Reports from businesses across the region suggested a "lacklustre economy," with companies unsettled by uncertainty surrounding the Budget.

• Employment: The Bank described employment plans as "marginally negative." Firms have become cautious due to market jitters, with many reporting they are not replacing staff who leave, opting for efficiency over recruitment.

• Consumer Confidence: Shoppers remain "cautious and keen on value for money." Some supermarkets fear the Budget will dampen spending on Christmas food and drink, although discounters report that early sales of lower-priced seasonal items are healthy.

According to the Office for National Statistics (ONS), a slowdown in food price rises was the key driver behind November's drop in inflation. However, Mr Bailey reiterated that while the rate of inflation is falling, prices are still rising, just at a slower pace.

Impact on Mortgages 🏠

The Bank's base rate heavily influences the borrowing rates set by high street banks for mortgages and loans, as well as the returns offered to savers.

• Tracker Mortgages: Around 500,000 homeowners with mortgages that "track" the base rate will see an immediate benefit. The 0.25 percentage point cut is expected to reduce monthly repayments by approximately £29.

• Standard Variable Rates (SVR): For the additional 500,000 homeowners on SVRs, monthly payments are expected to drop by an average of £14, provided lenders pass on the cut.

• Fixed Rates: The vast majority of mortgage customers are on fixed-rate deals and will not see an immediate change. However, market rates for new fixed deals have been falling recently in anticipation of this cut.

Future Forecasts

The Bank’s latest Monetary Policy Report adjusted its growth forecasts for the UK economy:

• 2025: Growth forecast at 1.5%.

• 2026: Growth expected to slow to 1.2%.

• 2027/28: Growth predicted to rise to 1.6% and 1.8% respectively.

While the aim of raising interest rates is to control inflation by cooling demand, the Bank faces a balancing act. Keeping rates too high for too long risks jeopardising the economy, as businesses may cut back on investment and jobs.