Hopes that interest rates will continue falling over the coming months have faded in recent days, with some economists now forecasting no further cuts until 2026. It comes after the Bank of England appeared divided at its August meeting.
Although the bank’s Monetary Policy Committee (MPC) cut the base rate to 4%, the decision rested on a knife edge and required two votes before the 5-4 majority was attained. Inflation also crept up to 3.8% in July, according to figures published on 20 August.
The Bank of England’s governor Andrew Bailey told the BBC that although the path for interest rates is still downwards, the course is now “a bit more uncertain”. This could mean fewer cuts before we reach the end of the rate-cutting cycle, or the same number of cuts but more spaced out.
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Before August’s meeting, Deutsche Bank was forecasting two cuts in the final quarter of 2025, coming in both November and December. It has now revised this to just one. It still thinks rates will ultimately settle at 3.25%, but not until the second quarter of 2026 rather than the first.
Research provider Pantheon Macroeconomics thinks we will see no further cuts before the end of the year, calling the MPC “materially more hawkish” in August’s meeting.
“A surprisingly large minority of four rate-setters – including the chief economist and deputy governor for monetary policy – wanted to keep rates on hold,” said Robert Wood, Pantheon’s chief UK economist. “Meanwhile, only one member of the MPC voted for a 50 basis-point rate cut, fewer than the two we had assumed, as Swati Dhingra surprisingly held back.”
Inflation becoming more of a concern
Although the economy and jobs market have been weakening, opening the door to more rate cuts, inflation has been rising and is becoming more of a concern for policymakers.
In its quarterly monetary policy report, published alongside August’s decision, the Bank increased its central inflation forecasts slightly, adding that the risks around medium-term inflationary pressures had “moved slightly higher” since its previous report in May.
The MPC now thinks inflation will peak at 4% in September before falling back after that, returning to the 2% target by 2027. It is also conscious of the risk that inflationary pressures could become more embedded, for example by impacting wage-bargaining behaviour.
“Bank officials have recently cited research showing that inflation has a tendency to become more entrenched when headline rates exceed 3.5-4%. The Bank’s newly-updated forecasts have headline CPI sitting within that range for the rest of this year,” said James Smith, UK economist at financial institution ING.
A tough tightrope for the Bank of England
The Bank of England has a tough tightrope to walk. It needs to support growth while simultaneously bringing inflation under control. Cutting rates could boost the economy, but it could also allow inflation to rise further.
Inflation has now jumped to 3.8% and the economy is slowing. The rate of GDP growth fell from 0.7% in the first quarter of the year to 0.3% in the second. While both GDP figures were above analysts’ expectations, the underlying picture looks less cheerful.
The Bank of England said first-quarter growth was driven by “temporary factors that provide little signal for underlying momentum in GDP” – things like businesses bringing activity forward in an attempt to get ahead of Donald Trump’s tariffs.
Meanwhile, the main driver of second-quarter growth was government spending. More important growth engines like household spending grew by a measly 0.1%, while business investment dropped by 4%.
The jobs market is showing signs of slowing too, with the unemployment rate creeping up and the number of vacancies falling. The rate of wage growth has also been coming down. Two months ago, policymakers were more concerned about the jobs market than inflation, but August’s meeting marked a shift in focus.
“The MPC's messaging has been inconsistent this year. Worries about labour market fragility have eased since June's very dovish minutes,” said Andrew Goodwin, chief UK economist at advisory firm Oxford Economics.
“The MPC's focus has now returned to the degree to which services inflation is cooling in response to labour market developments, and the impact of higher food and fuel prices on inflation expectations.”
Oxford Economics is still forecasting one more rate cut this year, coming in November, however this call comes with “much less confidence” than before.
“It wouldn't take much to convince the committee to pause for longer before cutting again. If inflation continues to surprise to the upside, this could tip the balance towards no change, particularly if market pricing moves against a rate cut,” Goodwin said.
What do falling interest rates mean for mortgages?
A drop in interest rates generally translates into cheaper mortgages. The average two-year fixed-rate mortgage deal is currently 4.97%, while the average five-year deal is 4.99% (21 August).
This is significantly cheaper than this time two years ago. At its peak in August 2023, the average two-year rate was 6.85% and the average five-year rate was 6.37%, according to financial information site Moneyfacts.
This is good news for those coming to the end of a two-year fix. A drop in average mortgage rates from 6.85% to 4.97% equates to a £458 drop in monthly repayments for someone with £400,000 of borrowing. These calculations assume a total mortgage term of 25 years, and are based on figures we plugged into MoneyHelper’s mortgage calculator.
Things don’t look so good for those coming to the end of a relatively cheap five-year deal agreed before rates started rising in 2021. Their monthly repayments are likely to jump when they refinance.
Around 1.6 million fixed-rate deals are due to come to an end in 2025, according to trade association UK Finance.
What do falling interest rates mean for savings?
Some of the top savings deals have disappeared over the past 18 months, first in anticipation of base rate cuts and then in response to them. A combination of rate cuts and rising inflation means savers are being squeezed on both sides.
Fewer than half of all available savings accounts now beat inflation. Data from Moneyfacts shows that 956 accounts now offer a real return, down from 1,558 a year ago.
“After almost a year and a half of savings growth, many savers are slipping back into earning negative real returns as inflation figures jump again,” said Caitlyn Eastell, a Moneyfacts spokesperson.
“With inflation running higher than the interest savings are now earning, money left languishing in a low-interest account is losing its spending power – making it tougher to achieve a sense of financial resilience.”
If you are happy to lock up your cash for a year or so, it could make sense to fix your savings to lock in higher rates for longer. The top one-year fixed account with no minimum deposit requirement currently offers 4.25%. You can earn 4.16% in an equivalent ISA.
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.
Those with a longer horizon ahead of them could consider investing some of their savings. A diversified portfolio of investments typically outperforms cash over the long run, but a minimum horizon of five years is generally recommended. We take a closer look in our guide on saving versus investing.
What do falling interest rates mean for annuities?
Annuities are a way of turning your pension pot into a guaranteed income for life. You buy an annuity by swapping it for your pension savings.
How much income you get in exchange for your pot depends on annuity rates. These are linked to UK government bond yields, which are in turn linked to the Bank of England base rate. A cut in interest rates generally translates into a fall in annuity rates.
As interest rates rose from 2022, the annuity market experienced a period of unprecedented strength. At the moment, annuity incomes are hovering near all-time highs.
Recent data from Hargreaves Lansdown’s annuity search engine shows a 65-year-old with a £100,000 pension could get up to £7,793 per year from a single-life level annuity with a five-year guarantee.
These incomes have led to a revival in a market that was once very much relegated to the sidelines, with last year proving a bumper year for sales.
Further interest rate cuts could result in annuity rates coming down, but the market still looks strong overall.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “Even if we do see incomes start to drift down, any movement should be fairly gradual, so interest should remain high. However, the prospect of further cuts coming down the line could persuade many to make a decision sooner rather than later.
“It’s a decision that shouldn’t be rushed. Once bought, an annuity cannot be unwound, so don’t leave room for regret. Scan the market before deciding on a quote and make sure you get the right kind of annuity for your needs.”
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