Rates remaining elevated for an extended period
Bank of England Lowers Interest Rates Amidst Economic Uncertainty
The Bank of England (BoE) has made a surprise move by lowering the Bank Rate to 4% from 4.25%, marking the first reduction since March 2023. This move, dubbed a "hawkish cut," comes as the BoE attempts to balance the need to control inflation with supporting a weak economy.
The decision was not unanimous, with five members of the Monetary Policy Committee (MPC) voting in favour of the cut, and four preferring to maintain the status quo. This internal disagreement highlights the delicate balance the BoE is trying to strike.
Inflation is forecast to peak briefly at 4.0% in September 2025 before gradually falling towards the 2% target. However, upside inflation risks remain, particularly from wages and prices potentially feeding further increases. The UK economy has experienced two consecutive contractions in April and May, and growth remains subdued.
The BoE's monetary policy stance is no longer restrictive, as the rate cut reduces the cost of borrowing. However, future reductions will be gradual to carefully monitor inflation and economic developments. The BoE emphasised it is not on a preset path and will respond to incoming evidence at its six-weekly meetings.
The impact on UK public finances and the state pension is complex. With borrowing costs easing from previous highs, the cost of servicing government debt will reduce somewhat, easing pressure on public finances. However, continued inflation above target and slow growth may pose challenges for fiscal sustainability going forward.
For state pensions, which are generally linked to inflation or wage growth, the current environment of slowing wage growth but sticky inflation could mean moderate increases. The gradual rate cuts might support some economic activity, indirectly benefiting public finances and pension affordability, but inflation risks remain a concern for the real value of pension payments.
Market expectations indicate potentially one or two more rate cuts this year, with the Bank Rate possibly settling near 3.5% in 2026 if disinflationary pressures continue to ease and growth remains soft. However, if inflation continues to rise, it could tip the balance towards no change in interest rates.
The triple lock on the state pension could cost Reeves billions of pounds more than expected if wage growth does not outpace inflation. On the contrary, if wage growth outpaces inflation, pensioners could look forward to a state pension increase of at least four per cent next year.
Rachel Reeves, a key Labour figure, praised the successive interest rate cuts, believing they would help mortgage holders and allow businesses to borrow more for growth. However, analysts at Capital Economics and Oxford Economics are less confident about another rate cut in November.
In a press conference, the BoE did not provide comments on how it would react to further tax rises. The MPC showed concern about food price inflation, and traders now believe there's only a 50% chance of a cut in November.
Sandra Horsfield, senior financial markets economist, stated that discussions behind closed doors might consider the consequences of the OBR downgrading productivity forecasts. AJ Bell's head of investment analysis Laith Khalaf stated that there is little chance of Reeves seeing a surprise interest rate cut at the next decision in September.
In summary, the BoE’s "hawkish cut" reflects a carefully managed transition toward lower interest rates amid competing risks: persistent inflation pressures that could flare up versus softening economic growth and labor market signs. This cautious outlook means interest rates will decline gradually, with close monitoring of inflation, growth, and labor market conditions to balance monetary stability with economic support.
- The Bank of England (BoE)'s decision to lower interest rates is aimed at supporting a weak economy, while balancing the need to control inflation, which impacts economy, finance, and markets.
- Businesses may benefit from the reduced cost of borrowing due to the BoE's monetary policy stance, although future reductions will be gradual to carefully monitor inflation and economic developments.
- Analysts predict potentially one or two more rate cuts this year, which could indirectly benefit businesses and public finances, including state pensions, but inflation remains a concern for the real value of pension payments.
