The Bank of England cut interest rates by 25 basis points at its most recent meeting on 7 November – the second cut this year. It means the base rate has now fallen from a 16-year high of 5.25% to 4.75%. This is likely to be our lot for the year. Most economists have ruled out a consecutive cut in December, after measures announced in the Autumn Budget altered the inflation outlook.
Chancellor Rachel Reeves unveiled £70 billion in spending policies and £40 billion in tax hikes, with the majority of this being funded by an increase in employer National Insurance contributions. There are fears that businesses could pass these costs on to consumers, putting prices up in an attempt to protect their margins.
An increase to the National Living Wage could also push costs up for businesses and keep wage growth high – good news for workers but less helpful when it comes to inflation. There are also concerns that higher government spending could add pressure at a time when the UK economy is already close to capacity.
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The fiscal watchdog says it expects policies announced in the Budget to push inflation up by 0.4 percentage points, once they hit peak effect. This might sound like a small number when you consider inflation hit 11.1% at its peak, but it has been enough to spook markets.
“A month or two ago, markets were pricing in a [...] Bank of England base rate as low as 3.5% by next Christmas, but 4% now seems to be the current consensus for 12 months’ time,” says Russ Mould, investment director at platform AJ Bell.
We examine the key variables at play, plus what it means for savers and mortgage rates.
Will interest rates continue to fall this year?
A December rate cut now looks unlikely. This is partly thanks to measures announced in the Budget, but even before Reeves’s fiscal statement, economists were on the fence. Almost two-thirds of those polled by Reuters between 22 and 28 October said they thought rates would be kept on hold at the final meeting of the year.
The latest inflation report shows prices rose by 2.3% annually in October, up from 1.7% in September. Analysts knew the figure would rise after energy prices surged 10% at the start of October, but the headline figure was still marginally higher than the 2.2% analysts were expecting. Inflation is expected to rise further as we approach the end of 2024, potentially reaching around 2.75% based on Bank of England forecasts.
While higher energy bills are a painful blow for household budgets, they matter less to the Bank of England than other categories. Services inflation is a particular area of focus for the MPC, as the sector accounts for around 80% of the UK economy. After tumbling from 5.6% to 4.9% in September, services inflation picked up slightly in October, reaching 5%.
The MPC is unlikely to sound the alarm bells at this marginal increase, though. As the economists at financial institution ING point out, within services inflation, there are some categories the MPC cares less about. “That’s things like rents, which were particularly strong on a month-on-month basis in October,” writes developed markets economist James Smith. “Airfares and package holidays, notoriously volatile categories, also explain some of the latest pick-up in services inflation.”
The measure looks closer to 4.5% when you strip out these categories and focus on the main areas the MPC watches, Smith says.
Where will interest rates settle longer term?
Interest rates are expected to fall further in 2025, although experts warn they are unlikely to return to the ultra-low levels we experienced for over a decade after the Global Financial Crisis. This is largely because the economic backdrop has shifted. Furthermore, the pace of cuts may be slower than previously hoped.
The team at Capital Economics, a consultancy, thinks the MPC will cut rates by 25 basis points every quarter until the middle of 2025. Previously, it thought the pace of cuts would speed up beyond this point, but has revised its forecast in response to the Budget.
Ruth Gregory, deputy chief UK economist, explains: “In light of the Budget, we revised up our GDP and core inflation forecasts. As a result, we no longer think the pace of rate cuts will quicken in the second half of 2025, and we now think rates will fall only as far as 3.50% in early 2026 rather than 3.00%.”
Capital Economics hasn’t changed its 3% estimate of the neutral rate, but instead thinks rates will stay above neutral for longer. The “neutral rate” can be defined as the rate at which the economy is in a state of equilibrium with full employment, stable inflation, and monetary policy that is neither contractionary nor expansionary.
How do interest rates control inflation?
Interest rates are the main tool the Bank of England uses to control inflation. In theory, when the MPC increases interest rates, it reduces the flow of money around the economy. Meanwhile, when it cuts rates, households have more money left over in their pocket to spend.
This works because higher interest rates make it more expensive for households to pay their mortgages and service any debts, which means they have less disposable income left over after paying for the essentials. When spending slows, prices rise more slowly too. Sometimes, they even start to plateau or fall if demand drops sufficiently.
It’s not just consumers that are impacted, though. Higher interest rates can also slow economic growth. They make it more expensive for businesses to borrow money, which ultimately hits their bottom line. If interest rates are kept high for long enough, the risk is that the economy slips into recession, which invariably results in an increase in the unemployment rate as businesses are forced to make cutbacks.
What do falling interest rates mean for mortgages?
Mortgage rates have fallen from their peak last summer, but remain significantly higher than the levels enjoyed for much of the past decade. In August 2023 both the average two and five-year fixed rates were above 6% at 6.85% and 6.37% respectively, according to Moneyfacts. Today they have fallen to 5.53% and 5.26%. But in 2019, both were below 3%.
There is still a fair amount of volatility in the market, and rates have picked up again slightly in recent weeks in response to the Budget and higher inflation expectations. This shows that mortgage rates don’t always fall in tandem with base rate cuts.
Barclays and NatWest are among the latest lenders to increase their fixed mortgage rates, effective 14 November. This followed similar changes from Santander, HSBC, Nationwide, TSB and others. Allied Irish Bank is the only provider now offering rates below 4%, according to broker L&C Mortgages.
“Unwelcome as it is for borrowers, it’s important to note that there’s no sign of rates skyrocketing as they have in recent years,” says David Hollingworth, associate director at L&C.
He adds: “The Bank of England base rate is still expected to fall over time, but markets are questioning if the pace will be as rapid. Forecasting and perception changes frequently but for now borrowers should grab a rate whilst they can, to avoid missing out if the deal is subsequently withdrawn.”
What do falling interest rates mean for savings?
Several providers have pulled their top savings deals over the past few months as interest rates have fallen. Some of the most competitive accounts still pay rates of around 5%, but savers will need to act quickly to take advantage of the current offering.
It could be worth fixing your savings if you have a pot of money you are willing to put away for a period of time. This should allow you to lock in higher rates for longer. See our round-up of the best easy-access rates, one-year savings accounts, regular saver accounts and cash ISAs for the latest deals on cash savings.
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