Bank of England cuts interest rates to 5% in first reduction since 2020

A senior Bank of England policymaker has warned the central bank could be forced to keep raising interest rates to prevent high levels of inflation from becoming entrenched in the economy.

The Bank of England has reduced interest rates for the first time in over four years, providing much-needed relief to millions of homeowners and families still grappling with the high cost of living.

In a closely contested decision announced at midday, the nine-member Monetary Policy Committee (MPC) voted 5-4 to lower the base rate by 0.25 percentage points from a 16-year high of 5.25 per cent. Governor Andrew Bailey supported the reduction, bringing the rate to 5 per cent.

This cut marks a significant step in easing the UK’s cost of living crisis. Interest rates had been on the rise since December 2021, increasing from a record low of 0.1 per cent to combat inflation, which intensified financial pressure on many families.

The MPC’s decision is expected to lead banks to lower mortgage rates shortly, though it will also result in less attractive savings deals.

Headline consumer price index inflation has stabilised at the Bank’s 2 per cent target for the past two months, the lowest level since July 2021. This stability fuelled speculation about a potential monetary policy easing for the first time since March 2020.

The five MPC members who supported the rate cut cited evidence of labour market rebalancing and easing wage growth, noting progress in reducing the risks of persistent inflation. Supply chain disruptions post-pandemic and Russia’s invasion of Ukraine had previously driven UK inflation to a four-decade high of 11.1 per cent.

Bailey stated, “Inflationary pressures have eased enough that we’ve been able to cut interest rates today.” However, he cautioned against expecting a rapid decline in borrowing costs, emphasizing the need for careful management to maintain low and stable inflation.

This cautious stance was echoed by the four MPC members who voted to keep rates unchanged. They argued that underlying domestic inflationary pressures remained entrenched, suggesting that long-term interest rates might need to stay restrictive.

The narrow 5-4 vote indicates a division within the committee on the resilience of inflation and the appropriate pace for lowering interest rates. Before the announcement, investors anticipated a reduction of around 0.50 to 0.75 percentage points this year.

The MPC is wary that price pressures could persist after the reduction in energy costs is no longer factored into inflation calculations. The Bank projects inflation will rise to 2.75 per cent in the second half of this year as energy price declines from the previous year are excluded from annual comparisons.

The committee has consistently pointed out that services inflation, a key measure of domestic price trends, remains high at 5.7 per cent, alongside elevated wage growth.

In its latest economic forecasts, the Bank of England significantly upgraded its UK GDP growth projection for this year to 1.25 per cent, up from a previous estimate of 0.5 per cent. This upward revision is expected to bolster the Labour government’s efforts to stimulate growth.

Leading up to the August meeting, the identification of MPC members likely to favour a rate cut was challenging due to the Bank of England’s communication pause during the general election campaign. MPC members typically express their views on inflation and monetary policy through public speeches.

In the end, Governor Bailey, newly appointed Deputy Governor Clare Lombardelli, and Sarah Breeden joined MPC members Dave Ramsden and Swati Dhingra in voting for the rate reduction. Jonathan Haskel, Catherine Mann, Megan Greene, and Huw Pill opposed the cut.

The Labour government is likely to highlight this rate reduction as evidence of economic normalisation under its leadership. Prime Minister Sir Keir Starmer has frequently blamed the Conservatives, particularly Liz Truss’s mini-budget, for previous interest rate hikes.

Earlier this week, Chancellor Rachel Reeves accused her predecessor, Jeremy Hunt, of concealing £21.9 billion in government overspending. Using a Treasury audit, she cancelled infrastructure projects and the winter fuel allowance for non-benefit-receiving pensioners. Reeves also indicated potential tax increases in her upcoming budget on October 30.

The MPC announced it would outline the pace of bond sales for the coming year at its next meeting in September.

The Bank of England has reduced interest rates for the first time in over four years, providing much-needed relief to millions of homeowners and families still grappling with the high cost of living.

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