Mortgage borrowers have been put on notice that interest rates will take longer to come down after the Bank of England warned Rachel Reeves’s budget would add to inflation while boosting economic growth.
Giving its verdict on last week’s budget as it announced a quarter-point cut in interest rates to 4.75% on Thursday, the central bank said the chancellor’s plans would drive up inflation to a fresh peak next year.
The Bank’s monetary policy committee (MPC) voted by a majority of eight to one to reduce rates for the second time this year to ease the pressure on households and businesses from high borrowing costs.
However, it said Reeves’s £70bn of additional spending backed by higher taxes and borrowing would add about 0.5 percentage points to headline inflation by the middle of next year and 0.75% to gross domestic product (GDP).
Updating its forecasts after taking budget measures into account, the Bank said it expected inflation would now peak at 2.75% by the middle of next year and then remain above the 2% target in 2026, until falling back in 2027 – a year longer than it had expected in its previous forecasts, published in August.
The pound rose against the US dollar after the Bank’s decision to cut rates, while financial markets reacted by betting that Threadneedle Street would cut interest rates fewer times and at a slower pace over the coming year.
“While cutting interest rates from 5% to 4.75% today, the Bank of England implied that the budget means rates will continue to fall only gradually,” said Paul Dales, chief UK economist at Capital Economics. He said rates were now on track to fall to about 3.5% by early 2026 rather than to 3%.
Threadneedle Street said it expected the government’s increasing of the rate of employer national insurance contributions (NICs) and the “national living wage” risked adding to inflationary pressures if companies passed on the costs in the form of lower wage rises and higher prices in the shops.
Other measures including raising the cap on bus fares and VAT on private schools could also push prices up. The development led one member of the MPC, the external economist Catherine Mann, to push for interest rates to be held at 5%.
Sarah Coles, head of personal finance at the investment platform Hargreaves Lansdown, said the slower pace of rate cuts would have an impact for hard-pressed households.
“The fact so few cuts are expected during 2025 will be a blow for anyone who was hoping for their mortgage to be less of a burden in the coming months,” she said.
The Bank of England’s governor, Andrew Bailey, signalled that borrowing costs were still likely to come down in future, although cautioned against expectations for rapid action.
“We need to make sure inflation stays close to target, so we can’t cut interest rates too quickly or by too much. But if the economy evolves as we expect it’s likely that interest rates will continue to fall gradually from here,” he said.
Inflation fell back to 1.7% in September – after peaking at 11.1% in October 2022 – but was already on track to return to above 2% after an increase in the Ofgem energy price cap for households in Great Britain in October.
Reeves said the interest rate cut would be “welcome news” for millions of families but that households were still facing a challenge after Liz Truss’s mini-budget.
She said: “Today’s interest rate cut will be welcome news for millions of families, but I am under no illusion about the scale of the challenge facing households after the previous government’s mini-budget.
“This government’s first budget has set out how we are taking the long-term decisions to fix the foundations to deliver change by investing in the NHS and rebuilding Britain, while ensuring working people don’t face higher taxes in their payslips.”
With expectations that Donald Trump’s US election victory would also pave the way for renewed inflationary pressures in the world economy, Bailey said a “gradual” approach to cutting borrowing costs was required.
He signalled the Bank would “wait and see” if Trump would impose sweeping import tariffs on America’s trading partners – as threatened by the president-elect during the campaign – while saying it was too early to “prejudge what might happen”.
However, he warned Britain was an open economy exposed to disruptions in global trade. “We do have to watch very carefully the fragmentation of the world economy … There are a lot of risks attached,” he said.
“There is greater uncertainty out there. First of all there is greater global uncertainty, without a doubt. The second thing to say is, of course there are domestic uncertainties. We need to obviously see how the budget measures pass through in terms of their economic effects.”
