Bank of England Cuts Interest Rates: What Will Be The Main Consequences?

On Thursday, the Bank of England reduced interest rates for only the second time since 2020, emphasizing a gradual approach to further cuts. The Monetary Policy Committee voted 8-1 to lower rates from 5% to 4.75%, attributing the decision to anticipated higher inflation and economic growth linked to the government's new budget. 

Let's discuss the major consequences of this.

Consequences of the UK rate cuts

The Bank of England's recent decision to lower interest rates to 4.75% is seen as a cautious step in response to high borrowing costs. While this cut aims to ease the financial strain on households and businesses, it comes with a longer timeline for further reductions.

The central bank anticipates slower progress towards its target inflation rate, as inflationary pressures from the government's budget policies could persist. The pace of future rate cuts is expected to be gradual, with rates potentially reaching 3.5% by early 2026. This slower trajectory will have significant consequences, prolonging the burden on mortgage borrowers and limiting the speed at which household finances improve.

Reeves's budget to add 0.5% to Inflation

The government's fiscal policies are expected to contribute to inflationary pressures, adding around 0.5% to the inflation rate by mid-2025. This increase stems from planned higher taxes, national insurance contributions, and increased public sector spending. 

The Bank of England forecasts that these measures will boost economic growth in the short term but delay inflation's return to the 2% target. As a result, the economy faces a delicate balance between stimulating growth and managing inflationary risks, with inflation likely remaining above the target until 2027.

Slower rate cuts are expected

Following the latest rate cut, the Bank of England has signaled that future rate reductions will occur at a slower pace than initially anticipated. While inflation has decreased from its peak, it is still expected to stay above the 2% target in the coming years.

The bank's cautious approach to rate cuts reflects its commitment to preventing inflation from spiraling while ensuring economic growth. With expectations that interest rates may only fall gradually over the next two years, businesses and consumers will likely continue to face high borrowing costs, limiting the pace of recovery in the housing market and the broader economy.

Prolonged mortgage burden to continue

The Bank of England's decision to reduce rates gradually means that mortgage holders can expect a prolonged period of financial strain. Although the recent rate cut to 4.75% offers some relief, it is insufficient to rapidly reduce the heavy burden of high mortgage rates that have burdened households in recent years. 

For many borrowers, the slower pace of rate cuts will mean sustained pressure on household budgets. As inflationary factors persist and rate reductions are expected to be more gradual, the hope of relief from high mortgage payments in the short term remains unlikely.

Inflationary pressure with employer NICs and living wage

The government's increase in employer National Insurance contributions (NICs) and the National Living Wage could contribute to further inflationary pressure in the UK economy. 

The Bank of England has warned that these measures, which are designed to provide greater support for workers, could lead to higher costs for businesses, which may be passed on to consumers in the form of increased prices. This creates a challenging dynamic for inflation control as businesses adjust to higher labor costs and attempt to maintain gains without exacerbating inflation further.

Slower decline in borrowing costs for households and businesses

The reduction in interest rates to 4.75% is a step towards easing the financial burden on households and businesses, but the decline in borrowing costs is expected to be slow. The Bank of England has indicated that the pace of rate cuts will be more gradual than originally expected, extending the period of high borrowing costs. 

This approach and external inflationary pressures suggest that households and businesses will continue to face challenges in managing debt and financing during the coming years. The slow reduction in borrowing costs could dampen consumer spending and investment, slowing economic recovery.

Pound to strengthen

The Bank of England's interest rate cut to 4.75% has immediately strengthened the British Pound against the US Dollar. The financial markets responded to the central bank's decision with an expectation of fewer rate cuts in the near future, which has helped bolster the currency. 

The Pound's appreciation reflects investor confidence that the UK economy may face fewer rate cuts compared to the Eurozone, providing some optimism for foreign exchange markets. However, the outlook remains cautious, as geopolitical risks and global economic uncertainties could continue to influence the Pound's performance in the coming months.

Government debt and fiscal stimulus in a low-rate era

The Bank of England's recent interest rate cut to 4.75% signals a shift in monetary policy. With inflation dropping to 1.7% in September, the central bank acted to support economic growth while keeping inflation in check. 

Despite fiscal concerns following the recent budget, which could increase inflationary pressures, the MPC voted 8-1 in favor of the cut. Experts suggest that the rate reduction could relieve borrowers but also slow future cuts' pace. With global economic uncertainties and domestic fiscal policies in play, the Bank is expected to proceed cautiously, ensuring stability while monitoring inflation trends.

BOE predicts a 0.75% increase in GDP

In November, the Bank of England cut interest rates by 25 basis points to 4.75%, its second rate reduction in 2024. The decision came amid easing inflation but was influenced by the UK government's fiscal policies, which raised inflation and growth forecasts. 

Inflation is now expected to rise to 2.75% next year before falling back to the 2% target, with growth increasing by 0.75%. BOE Governor Andrew Bailey emphasized a gradual approach to future cuts due to risks from global factors and domestic fiscal plans. Policymakers indicated that further easing would be cautious and moderate.

How will BoE rate cuts impact investors?

The Bank of England's rate cut offers some relief for borrowers but signals a gradual path for future reductions. Due to government fiscal policies, inflation is expected to remain above 2% until 2027, prolonging financial pressures on households and businesses.

While the Pound strengthened, traders may face challenges navigating slower economic growth and shifting market conditions. Slow easing and global uncertainties may further limit recovery, particularly in the housing market.