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Governor Andrew Bailey says the Bank expects to be able to cut interest rates further

The Bank of England (BoE) has reduced its interest rate to 4.5%, its lowest level in 20 months, offering some relief to mortgage holders across the UK.

This is the third cut to UK borrowing costs in the current cycle, following reductions in August and November last year.

The Bank’s Monetary Policy Committee (MPC) voted 7-2 to cut rates, after seeing inflation fall to 2.5% in December, closer to its 2% target.

Two policymakers wanted a steeper cut, of half a percentage point. One was Swati Dhingra, a dovish policymaker who has long been pushing for lower interest rates.

However, the second supporter of a more substantial reduction was an unexpected one — Catherine Mann, a traditionally hawkish policymaker. Mann, who has opposed previous rate cuts, surprised many by aligning with Dhingra in calling for a half-percentage-point reduction.

The pair both voted to reduce Bank Rate by 0.5 percentage points, to 4.25%, but were outvoted by the other seven, who voted to only cut to 4.5%.

The BoE governor Andrew Bailey said policymakers would take a “gradual and careful approach” to interest rate cuts.

Bailey said: “It will be welcome news to many that we have been able to cut interest rates again today.

“We’ll be monitoring the UK economy and global developments very closely and taking a gradual and careful approach to reducing rates further.

“Low and stable inflation is the foundation of a healthy economy and it’s the Bank of England’s job to ensure that.”

In the press conference that followed, Bailey added that the monetary policy committee expects to be able to cut rates further as “the disinflation process” continues.

Bailey said: “We expect to be able to cut the Bank rate further as the disinflation process continues.

However he cautioned that it might be a bumpy road ahead. He said: “But we will have to judge meeting by meeting how far and how fast.

“We live in an uncertain world and the road ahead will have bumps."

The BoE slashed its forecasts for UK growth this year, in a blow to the government. It now predicts UK GDP will only grow by 0.75% this year, just half the 1.5% it forecast back in November.

Chancellor Rachel Reeves is “not satisfied” with the level of growth in Britain’s economy. She said: "This interest rate cut is welcome news, helping ease the cost of living pressures felt by families across the country and making it easier for businesses to borrow to grow.

"However, I am still not satisfied with the growth rate. Our promise in our Plan for Change is to go further and faster to kickstart economic growth to put more money in working people’s pockets.

"That’s why we are taking on the blockers to get Britain building again, ripping up unnecessary regulatory barriers and investing in our country to rebuild roads, rail and vital infrastructure.”

Stagflation fears rise

Meanwhile the Bank of England said inflation, currently above target at 2.5%, is expected to peak at around 3.7% — up from a previous forecast peak of 2.8%. This is a result of higher energy prices and national insurance increases.

Laith Khalaf, head of investment analysis at AJ Bell, said: “The most striking announcement from the Bank of England today is not the cut in interest rates, but the prospect of inflation rising to 3.7% this year while its forecasts show the economy continuing to flirt with recession. Rising prices will not make for happy consumers who have might have hoped that high inflation is in the rear-view mirror.

“CPI at 3.7% is nowhere near the double-digit inflation we saw at the height of the cost of living crisis, but it adds to the cumulative load of price rises. It also sets up the potential for a round of higher salary negotiations, and with wage growth already running hot, this might stoke further inflationary pressures.

“The Bank can control these by keeping interest rates higher, which would mean more sustained pain for mortgage borrowers and for companies refinancing debt."

Kevin Brown, savings specialist at Scottish Friendly, said: "The UK economy appears to be at or near stagnation, and in dire need of the boost lower interest rates could provide. There is also the uncertainty surrounding the looming trade war set in motion by US tariffs.

Neil Birrell, chief investment officer at Premier Miton Investors, noted:"With growth under threat and inflation remaining higher than hoped, that provides a combination that is likely to see the word 'stagflation' being banded around," said

What does the interest rate cut mean for mortgages and savings?

The base rate, which serves as a benchmark for borrowing costs, directly affects mortgage rates, with tracker mortgages in particular following its movements. It also influences the rates individuals and businesses pay for loans.

According to the government's English Housing Survey, nearly a third of households have a mortgage, with approximately 600,000 homeowners holding tracker mortgages linked to the Bank’s base rate. For these individuals, the rate cut will lead to immediate reductions in their monthly repayments.

A 0.25 percentage point cut would typically save around £29 on the average monthly tracker repayment, according to UK Finance.

However, it’s important to note that those with tracker mortgages have seen their costs rise considerably over the past few years due to previous rate hikes, meaning their repayments are now significantly higher than they were before the base rate started to climb. For homeowners on standard variable rate (SVR) deals, the decision on whether to adjust rates lies with individual lenders, with most shifting borrowers to an SVR once their fixed-rate deals expire.

Sarah Coles, Yahoo Finance UK columnist and head of personal finance at Hargreaves Lansdown (HL.L), said: “If you’re on a fixed-rate mortgage, the rate cut won’t affect you immediately because it’s already priced into the market.”

According to Moneyfacts, the average two-year fixed rate has edged down from 5.56% in February to 5.52%, while the average five-year fixed rate has increased from 5.18% to 5.32%, both rising month-on-month. The five-year average, now at a six-month high, was 5.25% last month and 5.38% in August 2024.

For savers, the rate cut could result in lower returns on savings accounts. Mark Hicks, head of active savings at Hargreaves Lansdown (HL.L), said: “With the base rate widely expected to be cut next week, a lot of the reductions have already been priced into savings products.

"Those providers that are paying above base rate on easy access savings will have to reduce their rates as a result of the cut, in order to ensure they don't operate loss-making products.

The easy access savings market is expected to face pressure, while fixed-term accounts may see little change. Despite the rate cut, the cash ISA market remains highly competitive, with several providers still offering rates around or slightly above 5%.

"As we head towards the end of the tax year, it will be interesting to see if these providers can keep paying these rates, given they will likely already be operating them at a loss. The biggest driver will be if the market starts to price in more than three rate cuts over the medium to long term.”

The prospect of a rate cut doesn’t seem to be impacting annuities, which remain robust despite the BoE's move.

Helen Morrissey, Yahoo Finance UK columnist and head of retirement analysis at Hargreaves Lansdown (HL.L), warned: “Annuities are riding high, and not even the prospect of an impending rate cut seems able to burst their bubble.”

Currently, a £100,000 pension at age 65 can secure up to £7,492 per year from a single-life level annuity with a five-year guarantee, just below the record highs observed after the mini-budget.

Meanwhile, across the Atlantic, the US Federal Reserve held interest rates steady in the 4.25%-4.50% range, ending a run of three consecutive rate cuts since September.

This follows on from a hawkish rate cut in December, where Fed officials upgraded their inflation forecasts and only signalled two further cuts in their plan for 2025, which was fewer than expected.

In Europe, The European Central Bank (ECB) has cut interest rates by a quarter-point, as expected, in an effort to support economic growth and tackle stubborn inflation. After lowering key rates again in December, the benchmark rate on deposit facility has now fallen from 3% to 2.75%, its lowest level since early 2023.

The ECB lowered borrowing costs four times last year, with four moves anticipated in 2025, according to the swaps market.