UK Interest Rates Cut to 5%

Bank of England cuts interest rates first in four years. This is a relief for millions of homeowners, and families who are still struggling with the rising cost of living.

After holding borrowing costs at their highest level for more than 20 years, the nine-member monetary policy group (MPC), which is responsible for setting the UK’s base rate, announced a decision at midday that was hotly contested.

The group voted by 5-4 to reduce the base rate from 5.25 percent, a record high for 16 years. Andrew Bailey, Governor of the Bank of England backed a cut to 5%.

The interest rate reduction is another step in the UK’s cost-of-living crisis. In order to combat inflation, borrowing costs began to rise in December 2021 from a low record of 0.1 percent. They then increased at the fastest rate in a decade.

In the near future, banks are likely to lower mortgage rates as a result of this decision. It will, however, also lead to less attractive savings deals.

The Bank of England has been targeting a 2 percent inflation rate for headline consumer prices index for the last two months. This is the lowest level of inflation since July 2021. This has fueled speculation that the central banks will loosen their monetary policy, for the first since March 2020.

Five members of the MPC voted for the reduction of one quarter point, stating that they saw enough evidence to support a rebalancing of the labour market as well as a slowing of wage growth. The five members of the MPC who backed the quarter-point reduction said that they had seen enough evidence of a rebalancing in labour market and an easing in wage growth.

After the end of the pandemic lockdowns in February 2022 and Russia’s invasion in Ukraine, supply chain problems pushed inflation to its highest level in four decades.

Bailey said, “Inflationary Pressures have Eased Enough That We’ve Been Able To Cut Interest Rates Today.”

In a cautionary note, he warned businesses and households not to expect a rapid decline in borrowing costs. The Bank Governor said: “We must ensure that inflation remains low and we should be cautious not to reduce interest rates too rapidly or too drastically.”

He said: “The best thing we can to do is ensure low and stable inflation in order to support the economic growth and prosperity of the nation.”

Bailey’s hesitation was reflected by MPC members voting to maintain borrowing costs. Four members of the MPC, including Huw Pil, the Bank’s Chief Economist, stated that “underlying inflationary pressures appear more entrenched”. They also said that interest rates on the long term might need to be restrictive in order to keep inflation under control.

The vote pattern of 5-4 shows that there is a split in the committee regarding how inflation will behave over the next few months, and how fast interest rates should be reduced. Investors believed that the Bank of England would reduce rates by 0.75 or 0.50 percentage points in this year.

The MPC is worried that the price pressures may be difficult to control after the energy cost reductions are not included in the calculation of inflation. The Bank stated that the inflation rate was expected to rise to 2.75 percent in the second half this year, “as the declines in energy costs last year are not included in the annual comparison”. This will reveal more clearly how persistent the domestic inflationary pressures remain.

MPC members have repeatedly stressed that service inflation, a measure of domestic price dynamics, remains too high. At 5,7% it is well above group forecasts. The wage growth rate is also high at 5.7%.

In its forecasts, released along with the announcement of rates, the Bank has also significantly upgraded its projections on GDP growth for this year. The Bank of England has also increased its projections for GDP growth this year in the forecasts released alongside the rate announcement.

In the lead up to the August meeting, traders were unable to identify MPC Members who would be inclined to support a rate reduction after the Bank of England had halted communication during the general elections campaign. The rate-setters often give speeches in which they outline their views on inflation, and how monetary policy should be reacted to it.

In the end, Bailey, Clare Lombardelli, the newly-minted deputy governor, and Sarah Breeden voted with Dave Ramsden, Swati. Dhingra, and other MPC members to reduce rates. Jonathan Haskel and Catherine Mann wanted to hold rates.

Labour will use the rate reduction as an indication that the economy is already beginning to normalize under their short tenure. The prime minister Sir Keir starmer has repeatedly blamed the Conservatives, and specifically Liz Truss’ mini budget, for driving interest rates up.

Rachel Reeves was the chancellor at the time and accused her predecessor Jeremy Hunt of hiding £21.9 billion in overspending. She used results from a Treasury audit to scrap the infrastructure projects, and winter fuel allowances for pensioners who do not receive benefits. Reeves acknowledged that taxes were likely going to increase in her first budget, which was presented on October 30, 2017.

Reeves stated on Thursday that, “While the interest rate cut today will be welcomed news, millions are still facing higher rates of mortgage after the mini budget.” This government is making the tough decisions to rebuild Britain after years of low economic growth.

At its next meeting, scheduled for September, the MPC will announce the pace at which it plans to sell bonds in the coming year.