Interest rates have been reduced for the first time in over four years, though the Bank of England has cautioned that borrowing costs are unlikely to decrease significantly in the near future. On Thursday, the Bank lowered rates from 5.25% to 5%, marking the first reduction since the pandemic began in March 2020.
Interest rates influence borrowing costs set by banks and lenders for mortgages and credit cards. Andrew Bailey, the Bank of England’s governor, noted that while policymakers supported the rate cut, they remain focused on ensuring that inflation— the rate of price increases— remains subdued. Recent years have seen a rise in interest rates, impacting household finances but improving savings returns.
The drop to 5% will immediately benefit some homeowners with variable-rate mortgages by reducing their monthly payments. However, savers may experience lower returns. Bailey stated, “Inflationary pressures have eased enough for us to reduce interest rates today,” but he warned against expectations of a rapid decline in borrowing costs. “We need to ensure inflation remains low and avoid cutting rates too quickly or too drastically,” he added.
The decision was closely contested, with five of the nine-member committee, including Bailey, supporting a quarter-point reduction. The Bank’s chief economist, Huw Pill, was among the four who preferred to maintain current rates.
While some homeowners will benefit from the rate cut, the Bank of England indicated that others might face future mortgage challenges. Approximately a third of those with fixed-rate mortgages are currently paying less than 3%, thanks to earlier lower rates. The Bank noted that many of these loans will expire before the end of 2026, potentially leading to higher effective interest rates in the future.
Inflation hit the Bank’s 2% target in May and remained steady in June, but core inflation, which excludes volatile items like food and fuel, remains high. The Bank expects inflation to rise slightly in the latter half of the year due to increasing energy costs as winter approaches. Wage growth has slowed, but the committee is keeping an eye on it. They do not anticipate a significant impact from the recent public sector pay rises announced by Chancellor Rachel Reeves.
Reeves announced wage increases of 5% to 6% for public sector workers, including NHS staff and teachers, and criticized the previous Conservative government for leaving a £22 billion “black hole” in public finances. The Conservatives have countered, suggesting Labour is preparing for tax hikes in the upcoming Budget on October 30.
The Bank of England confirmed that it had been briefed on the Treasury’s figures prior to Reeves’ statement but noted that it was too late to incorporate these details into its Monetary Policy Report. The report, which outlines growth forecasts, was updated to reflect an improved outlook for the UK’s economic growth in the first half of the year. The Bank now expects GDP to grow by 0.7% between April and June, an upgrade from the previous forecast of 0.2%. However, growth is anticipated to slow in the second half of the year due to weakening business momentum.