The Bank of England cut interest rates at its first meeting of the year on 6 February, bringing the base rate from 4.75% to 4.5%. Markets are now warming up to the idea that the Bank could cut rates two or three more times before the year is out.
Two members of the MPC voted to reduce rates by 50 basis points during the meeting, but were outweighed by the remaining seven who opted for a 25 basis point cut.
At the start of the year, markets were only pricing in around two cuts in 2025 overall, but slowing UK growth has prompted stagflation fears. The disappointing growth outlook could encourage the MPC to cut rates more quickly going forward, particularly after halving its 2025 growth forecast from 1.5% to 0.75%.
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While markets have only recently caught up on the rates outlook, economists have been forecasting a slightly more aggressive approach for some time. Experts at institutions like Goldman Sachs, ING and Capital Economics are all predicting one rate cut per quarter.
James Smith, developed markets economist at ING, says he expects the next cut to come in May, with further moves in August and November.
A move at the next meeting in March hasn’t been completely ruled out, though.
Two meetings ago, three MPC members signalled that they wanted to cut rates at a more rapid pace, and Catherine Mann’s vote for a 50 basis point cut last week suggests she could join them.
Capital Economics calls the March meeting a “humdinger”. If Mann joins the more dovish contingent, “it would only take one member to swing the majority to cutting rates by 25 basis points,” the consultancy explains.
Despite this, the Bank of England remains cautious in its language. In its summary statement after the February meeting, it said that a “gradual and careful approach” to cutting rates remained appropriate.
Is inflation rising again?
Inflation briefly touched the Bank of England’s 2% target last year, before rising again. It came in at 2.5% in December, down slightly from 2.6% the month before.
The headline rate is expected to rise further over the months to come, largely driven by a global uptick in energy prices. The latest forecast from the Bank of England suggests inflation could briefly hit 3.7% in the third quarter.
Despite this, the MPC expects domestic inflationary pressures to wane further. For example, one area where we should see ongoing improvement is in the services inflation basket. This has been an important metric for the Bank of England when weighing up each interest rate decision.
Until recently, UK services inflation has been persistently high – and higher in the UK than elsewhere. Services make up around 80% of the UK economy, so this suggested that domestic inflationary pressures were still fairly embedded.
The latest inflation reading showed services inflation has now fallen to 4.4%, down from 5% in November. It is no longer so far out of kilter with other economies.
Furthermore, the economists at ING think services inflation could see a significant drop in April when index-linked contracts like broadband and phone deals come up for renewal. “Owing to lower headline inflation, these should be less aggressive than at the same point last year,” its economists write.
Risks to the interest rate outlook
Although three more cuts look likely this year, there are some risks on the horizon. For example, changes announced in the Autumn Budget could unleash new domestic inflationary pressures.
From April, employers will have to start paying higher National Insurance contributions, and the National Living Wage will also rise by 6.7%. Some businesses have said they will need to increase their prices to pass some of these costs on to consumers.
Tariffs from US president Donald Trump could also push costs up for businesses on a global scale, thereby fanning the embers of inflation.
There is still a large degree of uncertainty, though – and the flipside is that both of these measures could dampen economic growth. If this happens, central banks may be forced to cut rates more rapidly.
What do falling interest rates mean for mortgages?
Mortgage rates have fallen from their peak, but remain significantly higher than the levels enjoyed for much of the past decade.
- Peak rates: 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’s rates: As of 10 February, average rates have fallen to 5.49% and 5.3%.
- Pre-pandemic rates: In 2019, both the two and five-year rates were below 3%.
The interest rate outlook is generally priced into the mortgage market in advance, meaning an interest rate cut doesn’t always result in a rapid tumbling of mortgage rates. Furthermore, rates have actually ticked up slightly since the start of the year after gilt yields surged in January.
“While mortgage rates are linked to the base rate, they aren’t directly based on them,” explains Laura Suter, director of personal finance at investment platform AJ Bell. “Instead they are reliant on swap rates, which track government bond yields – so bond market turmoil raises yields, increasing borrowing costs for banks and, in turn, mortgage rates.”
Despite this, mortgage rates should fall further later this year if further base rate cuts materialise.
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. With this in mind, it could make sense to fix your savings if you have a pot of money you are willing to put away for a period of time.
Savers should also read the terms and conditions carefully when shopping around. For example, Chase currently offers a market-leading deal on its easy-access account, paying 5%. However, this will come to an end in the coming days with a double-whammy of cuts due in February. The first is due on 13 February, and the second on 19 February.
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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