Bank of England cuts rates to four percent amid warning on rising inflation and fiscal challenges

The Bank of England has lowered the UK base interest rate by 0.25 percentage points to 4 per cent, marking the lowest level in over two years. The decision was reached after an unprecedented second ballot among members of the monetary policy committee MPC, with the vote split 5 to 4 in favour of a cut. This rare division highlights the deep uncertainty gripping policymakers as concerns grow over the trajectory of inflation and the broader economic outlook.

Andrew Bailey, the Bank’s governor, described the rate decision as “finely balanced” and cautioned against expecting further cuts in the immediate future. The Bank’s latest forecasts suggest inflation will reach 4 per cent in September, a near three year high, driven largely by higher food and energy costs along with rising household utility bills. This anticipated surge in prices is set to complicate the Government’s finances, particularly with benefit and pension settlements expected to rise steeply before the autumn budget.

The recent increase in employers’ national insurance contributions and a 6.7 per cent hike in the minimum wage have resulted in “material increases in labour costs,” according to the Bank. These changes have been cited as significant contributors to rising food prices, with supermarket labour costs disproportionately affected due to a high prevalence of part time staff and a lower earnings threshold triggering the levy.

The introduction of the packaging levy under the extended producer responsibility EPR scheme is also adding to inflationary pressures. This legislation, which shifts the cost of packaging waste management from local authorities to businesses, is forecast by the Bank to add 0.5 percentage points to food inflation, pushing food price growth towards 5.5 per cent by year end. The EPR scheme, first legislated under the previous Conservative government and detailed by Labour in June, is expected to encourage recycling but will ultimately raise grocery bills for consumers.

Recent economic data show headline inflation running at 3.6 per cent, double the Bank’s 2 per cent target. Government borrowing costs have increased and the pound has strengthened against the dollar following the rate announcement, while UK equity markets experienced a modest decline. Economists warn that continued inflation, persistent deficits and policy uncertainty may erode this fragile financial stability, with Chancellor Rachel Reeves facing the prospect of bridging a £30 billion fiscal gap through a combination of spending cuts and tax rises at the next budget.

The economy is expected to grow by 1.25 per cent this year, with unemployment set to peak at 4.9 per cent. However, external headwinds loom, including US tariffs which could reduce UK GDP further if financial volatility intensifies. While some MPC members emphasised the need for a rate cut to counteract rising unemployment and subdued consumer spending, others called for further evidence that inflation is on a consistent downward path before supporting additional monetary easing. The future direction for interest rates remains far from certain as policymakers navigate a challenging economic landscape.