The Bank of England has made headlines once again, cutting interest rates as part of its monetary policy response to budget-related inflationary pressures. On Thursday, the central bank lowered the base interest rate from 5% to 4.75%, marking its second cut this year. Governor Andrew Bailey indicated this was not just about easing the burden of borrowing on households and businesses; it had to be tempered with caution due to rising inflation forecasts linked to the government’s recent budget policies.
The reduction, by 0.25 percentage points, came surprisingly after about 16 months of elevated rates, which had reached peaks not seen for over a decade. Previously, bank rates had been held at this high level as inflation soared, reaching 11.1% at its 2022 peak. Recently, the situation improved somewhat with inflation recorded at 1.7% as of September, down from its prior highs. This fall was primarily driven by decreasing petrol prices and lower airfares.
Yet, the latest financial figures and forecasts point to potential challenges. The Monetary Policy Committee (MPC) concluded their recent meeting with the realization the government's newly proposed budget, introduced by Chancellor Rachel Reeves, would inject more inflationary pressures. It is estimated those pressures could add up to half a percentage point to inflation over the next two years.
Reeves's budget entails significant public spending and tax increases aimed at boosting economic growth. Critics, including the MPC member who voted against the rate cut, expressed concerns these strategies would only exacerbate price pressures, making it tough for the Bank to control inflation long-term. The committee predicted inflation could peak at 2.75% mid-next year and remain above the Bank's target of 2% until late 2026.
Despite the moderate optimistic tone surrounding the rate cut, several lenders have already reacted to the budget announcement by raising fixed mortgage rates. Institutions such as Virgin Money, Halifax, and Coventry Building Society have upped their fixed mortgage costs by as much as 0.25 percentage points. For example, average rates for two-year fixed mortgages shifted from 5.39% to 5.42% within days. Savvy borrowers are encouraged to act quickly if they are considering fixing their mortgage rates to secure the best deals before rates potentially escalate even more.
The shaky ground beneath these changes is made clear by the Governor’s warnings: “We need to make sure inflation stays close to target, so we can't cut interest rates too quickly or by too much.” Bailey underscored the necessity of adopting a gradual approach to interest rate adjustments, implying more cuts on the horizon but with strict conditions attached.
Despite attempts to mitigate immediate pressures from high borrowing costs, debt-laden households are left grappling with the repercussions of previous economic decisions. For households on standard variable rate mortgages, projections indicate monthly repayments may decrease by about £17.17 following the rate cut. While tracker mortgages stand to lose around £28.98 each month, it's clear many families are still facing considerable financial strain.
Experts have pointed to the complex scenario laid out by the Chancellor’s recent moves. For one, increases to taxes and national insurance contributions signal more stringent financial obligations for businesses—leading to foreseen rises in consumer costs. The MPC is closely monitoring how these budget policies will ripple through the economy. Economic growth is projected to rise by 0.75 percentage points at its peak compared to previous forecasts within the next year due to this spending.
While the interest rate cut is intended as some positive news amid economic hardships, it does not erase challenges. Rachel Reeves herself acknowledged the hurdles remaining for average families, stating: “The interest rate cut will be welcome news for millions of families, but I am under no illusion about the scale of the challenge facing households after the previous government’s mini-budget.”
All signs point to the fact the Bank is walking a tightrope—aiming to balance between supporting economic growth through lower borrowing costs, yet not igniting new inflation fires by acting too hastily or aggressively. The current economic climate, characterized by persistent uncertainties both domestically and internationally, means the future direction of interest rates remains somewhat unpredictable. Investors and homeowners alike will be waiting with bated breath to see how these developments play out over the coming months.
Overall, the central bank remains committed to ensuring the UK economy reaches its goals without falling headlong back toward rampant inflation—a tightrope walk between necessary stimulus and fiscal discipline. And as the dust from the recent budget settles, the economy will be faced with the dual pressures of stimulating growth and controlling inflation, with less optimism about swift solutions to the underlying issues at hand.
