UK interest rates have been held at a 16-year high since August last year, leaving many households and businesses feeling stretched by higher mortgage costs and debt repayments.
Hopes are high for a first interest rate cut later this year, although opinions diverge on precisely when this might happen.
The latest survey from Reuters, conducted between 18 and 24 July, suggests over 80% of economists expect a first move on 1 August. However, markets are only pricing in a 45% chance of a rate cut, suggesting the decision could rest on a knife edge.
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The headline rate of inflation slowed to 2% in May and held steady in June. However, core and services inflation remain more of a concern at 3.5% and 5.7% respectively. The services sector accounts for around 80% of the UK’s economic output, so the Bank of England watches this measure closely.
What’s more, a lot of the language experts are using when talking about services inflation remains fairly hawkish, suggesting August could be too early for a first move from UK policymakers.
The International Monetary Fund (IMF) recently warned that high services inflation is “holding up progress on disinflation [globally], which is complicating monetary policy normalisation”.
Huw Pill, the Bank of England’s chief economist, delivered a similar warning in a speech earlier this month.
Against this backdrop, we examine the key variables at play. How many meetings does the Bank of England have left this year, when will we see the first interest rate cut, and what will it mean for savers, mortgage rates and house prices?
Will the Bank of England cut interest rates this summer?
Barring any economic shocks, interest rates have peaked. The question now is how long the Bank of England will hold rates at 5.25%. The Bank has four remaining meetings this year, with the next announcement due to take place on 1 August.
Over the past few months, we have seen the MPC start to turn – however it remains visibly divided. In February and March’s meetings, one committee member voted for a rate cut. This increased to two committee members in May and June.
We have seen a shift in economists’ expectations too. Although the latest Reuters poll showed more than 80% of economists still expect a rate cut in August, that’s down from almost 97% when they were polled previously in June.
Services inflation is the main factor that has driven the change in sentiment in recent weeks, but wage growth is still coming in hot too at 5.7%. What’s more, May’s economic growth figure (0.4%) came in at double the rate expected when released on 11 July.
“This snapshot of an economy growing a bit faster than forecast, could make Bank of England policymakers that bit more reticent about voting for an interest rate cut on 1 August,” says Susannah Streeter, head of money and markets at Hargreaves Lansdown.
Finally, it is unclear whether the recent general election result will feed into the Bank of England’s thinking.
The MPC has a responsibility to act independently, but it may not want to make any decisions until the new government publishes its first Budget statement. Chancellor Rachel Reeves has suggested this could take place as early as September.
The new government will be “changing policy, taxes and the fortunes of the UK economy, all of which play into the economic data the Bank scrutinises every month,” explains Laura Suter, director of personal finance at AJ Bell.
How do interest rates control inflation?
In theory, when the UK central bank increases interest rates, it reduces the flow of money around the economy.
Higher interest rates make it more expensive for households to pay their mortgages and service any debts, which means they have less cash left over for spending. 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.
When setting interest rates, policymakers have to walk the tightrope between controlling inflation and maintaining growth. So far, UK economic growth has proved fairly resilient. The UK dipped into a brief and shallow recession at the end of 2023, but has since emerged.
What will a fall in interest rates mean for mortgages and house prices?
Ever since Liz Truss’s disastrous mini-Budget, mortgage rates have been significantly higher than those seen towards the end of the 2010s. Rates rose even more last summer as markets began to question how fast inflation would fall, if indeed it would fall at all.
The good news is that much of the impact of higher mortgage rates has already been passed through to mortgage holders, meaning there will (hopefully) be no more nasty surprises for most homeowners when they come to remortgage. However, the bad news for around 1.6 million mortgage holders is that their deals will expire this year.
Mortgage rates are expected to come down once the Bank of England starts cutting the base rate. In fact, they have already started to fall slightly in recent weeks in anticipation of a possible cut in August or September.
In turn, this could boost the housing market, which has been dampened by higher mortgage rates in recent months.
House prices typically rise when interest rates are cut, as affordability constraints loosen and buyer demand picks up. This is something to keep an eye on if you are thinking about the best time to buy or sell your house.
What will it mean for my savings?
Savings rates rose rapidly last year, but are now starting to plateau and, in some cases, fall. Many of the best savings rates are already disappearing from the market. Even if the base rate isn’t cut this summer, it is only a matter of time before it starts to come down.
“The implications of any possible reductions to the base rate may mean some people will be keen to grab a deal quickly and review their existing accounts,” says James Hyde, Moneyfacts spokesperson.
He adds: “For those willing to lock their cash away for a set period, there are still some one and two-year fixed bonds paying over 5% interest. Some easy-access accounts also pay above this threshold at present, though these rates are subject to change with very short notice.
“Whichever options savers choose, any clear indications of an impending base rate cut could lead to significant movement in the market, so it’s always worth keeping an eye out and being prepared to switch if necessary.”
Check out our round-up of the best easy-access rates, one-year savings accounts, regular saver accounts and cash ISAs.
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