The Bank of England has cut its base interest rate from 4.25% to 4% in a narrow vote, delivering relief to mortgage holders and borrowers despite inflation rising to 3.6% in June. The decision marks the central bank’s fifth rate reduction since August 2024 and brings borrowing costs to their lowest level since March 2023.
The Monetary Policy Committee (MPC) voted by a slim 5-4 majority to implement the quarter-point reduction at its meeting on Thursday, with two members preferring a larger half-point cut whilst two others wanted to hold rates steady. The decision underscores the delicate balancing act facing policymakers as they navigate between stubborn inflation and a weakening economy.
The rate cut comes as fresh data reveals the UK economy contracted for two consecutive months, with GDP falling 0.1% in May following a 0.3% decline in April, according to the Office for National Statistics. Meanwhile, unemployment has jumped to 4.7% in the three months to May – the highest level in four years.
Economic Pressures Mount
Chancellor Rachel Reeves will welcome the decision as she attempts to stimulate economic growth amid mounting challenges. The UK economy grew 0.7% in the first quarter of 2025, but economists warn this performance is unlikely to be repeated as business confidence wanes and hiring slows.
“The global trade war, National Insurance hikes, and a lack of certainty and direction from the government around what will happen in the next Autumn Budget continues to impact economic growth,” said Alastair Douglas, CEO of TotallyMoney.
The labour market has shown particular signs of strain, with payrolled employees falling by 41,000 in June, worse than the 35,000 decline economists had anticipated. Average earnings growth excluding bonuses has eased to 5% in the period to May, reaching its lowest level in almost three years.
Bank of England Governor Andrew Bailey had previously signalled the institution’s readiness to cut rates if the jobs market weakened. Speaking to The Times in July, Bailey indicated the MPC was prepared to make larger cuts if employment conditions deteriorated significantly.
Inflation Concerns Persist
The decision to cut rates despite inflation running at 3.6% – well above the Bank’s 2% target – reflects policymakers’ assessment that price pressures are temporary. Consumer prices rose by 0.2 percentage points in the 12 months to June, but the Bank expects inflation to fall back towards target next year.
“There will be hopes that if loans become cheaper, it will help boost consumer and business confidence but there’s a long way to go,” said Susannah Streeter, head of money and markets at Hargreaves Lansdown, speaking before the decision.
The Bank faces a complex economic landscape, with production output falling 0.9% in May and construction declining 0.6%. Only the services sector showed marginal growth of 0.1%, insufficient to prevent the overall economic contraction.
Market Impact
Sterling rose 0.5% against the dollar to $1.3424 following the announcement, as markets digested the narrowness of the vote. The close decision suggests deep divisions within the MPC about the appropriate pace of monetary easing.
For homeowners, the rate cut brings immediate relief. UK Finance calculates that the 591,000 households on tracker mortgages will see monthly payments fall by £29 on average. Those on fixed-rate deals, which comprise 85% of existing mortgages, won’t benefit immediately but may find better rates when remortgaging.
Current market data shows the average two-year fixed mortgage rate stands at 5.02%, whilst five-year deals average 5.01%. These rates remain significantly below the peak of August 2023, when two-year rates hit 6.85%.
Business Response
The fintech sector, which has suffered under higher rates, welcomed the move. Douglas noted that increased competition in the market has already led to longer balance transfer periods and improved customer options.
Further cuts will help stimulate the economy, by reducing the cost of borrowing, and driving investment,” he said. Fintech has felt the brunt of higher rates, but with more money moving into the sector, and new technologies driving innovation, we should see faster improvements in both financial services and customer outcomes.
However, businesses continue to grapple with rising costs. The increase in employers’ National Insurance contributions and the national minimum wage introduced in April has particularly affected the hospitality sector, contributing to job losses.
Future Outlook
Analysts are pricing in at least one more quarter-point rate cut in 2025, potentially bringing the base rate to 3.75% by year-end. The International Monetary Fund expects two cuts before Christmas, whilst investment bank ING forecasts reductions in both August and November.
The Bank of England has emphasised its “gradual and careful” approach to monetary policy, suggesting any future cuts will depend on incoming economic data. The next MPC meeting is scheduled for 18 September, with subsequent decisions due on 6 November and 18 December.
Deutsche Bank’s chief UK economist Sanjay Raja warned that second-quarter growth could come in weaker than the Bank’s 0.25% forecast, potentially justifying further monetary easing. However, he added that the economy was not “faltering,” citing improved household and business sentiment.
The Bank faces an increasingly uncertain global environment, with its statement noting that “uncertainty surrounding global trade policies has intensified” following US President Donald Trump’s tariff announcements. Whilst the central bank expects limited direct impact on UK growth and inflation, the broader economic uncertainty adds to the challenges facing policymakers.
For savers, the rate cut brings unwelcome news. Annuity rates, which have hovered near all-time highs, may begin to decline. Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, warned that “with rate cuts looming, there is a chance that we could see these incomes come down over the coming months.”
As the UK economy navigates between persistent inflation and weakening growth, Thursday’s narrow vote underscores the difficult choices facing the Bank of England. With unemployment rising and GDP contracting, the pressure for further rate cuts is likely to intensify in the months ahead.
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