- Base rate cut to 4.25% but two year gilt yield rises
- This probably reflects two members of the MPC voting to keep rates on hold
- Bank reckons Trump tariffs will be more disinflationary than inflationary for the UK
- Transitory inflation is back, but Bank now reckons 3.5% is the 2025 peak for CPI
- Will interest rates be cut to 3.5% by the end of the year?
- The impact on personal finances: don’t bank on a flurry of better mortgage deals
Laith Khalaf, head of investment analysis at AJ Bell, comments on the latest Bank of England interest rate decision:
“Trump’s tariffs have fed directly into this interest rate cut by pushing down energy prices, which has lowered the UK’s inflation forecast. That’s opened up space for the Bank of England to cut rates, even though inflation is expected to head upwards. The Bank now expects CPI to peak at 3.5% later this year, down from its previous forecast of 3.75%. It also reckons the rise in inflation will be temporary, which sounds a whole lot like the transitory inflation the Bank thought would dissipate in 2022, but in fact turned into the cost-of-living crisis. We should be wary of falling into the boy who cried wolf fallacy here. They may have previously got it badly wrong, but this time they may well be right.
“That’s particularly the case when you consider the economic effects of US trade policy. The Bank reckons tariffs will be more disinflationary than inflationary, and there are some warning signs in the forecasts of what may be to come. In particular, economic growth expectations have been pared back, and UK unemployment is now forecast to hit 5% at the back end of 2026. A generous pinch of salt is a required condiment when digesting the Bank’s forecasts seeing as the true end-state of US trade policy may look very different to its current configuration, and could slide in any plausible direction, or indeed an implausible one which has not yet been countenanced. Economic reality may turn out to be strongly divergent from the Bank’s forecasts, for better or worse.
“For that reason it’s best not to bet the house on interest rates being cut to 3.5% by the end of this year. That’s what the market currently expects, and based on the Bank’s forecasts would serve to bring inflation back to 2% in the medium term. But with such a high degree of uncertainty around the forecasts, it would be unwise to ink three more rate cuts in this year. Indeed, the latest trade deal between the US and the UK has rendered the Bank’s forecasts obsolete by the end of the day they were published.”
Market reaction and the impact on personal finances
“The market did not immediately react in the way you might expect to an interest rate cut. The yield on the two year gilt rose from 3.8% to 3.88%. This probably reflects the fact a rate cut was already priced in, but a split vote in which two members of the Bank’s committee voted to keep rates on hold was not. The split vote meant the market saw this as a hawkish interest rate cut, even though two members of the committee wanted to go further and cut rates to 4%. The three way split is no doubt a result of the economic uncertainty stemming from global trade ructions creating a diversity of opinion on the best path for monetary policy.
“Swap rates, on which fixed term mortgages are priced, actually rose a touch on the back of the announcement, probably due to the split vote too. That may well put a cork in the flurry of mortgage rate cuts we have seen in recent weeks, though some lenders may still have cuts in the pipeline yet to be announced. Variable rate mortgages can still be expected to fall, however. Trump’s tariffs have definitely led to falling fixed mortgage rates so far, but whether that continues to be the case depends on the final implementation, and the reaction of interest rate markets. Lenders may also be looking at the economic picture, in particular the potential for unemployment to rise, and think this is no time to be heroic by slashing rates. Unfortunately for mortgage borrowers, guessing the future direction of the mortgage market right now is like a high stakes game of blind man’s buff.
“Cash savers will also note that interest rates and the inflation rate are converging. That means variable rate accounts will start to be pinched in terms of providing a real return, if only in the short term, assuming the Bank’s assessment that inflation is temporary proves to be correct. At the most competitive end of the market, there are still accounts offering rates well in excess of the rate of inflation, though that may not be the case once tax is taken into account. Hence why some cash savers have switched to the low coupon gilt market where returns can be harvested largely tax-free.
“The less competitive end of the savings market is not so well insulated from rising inflation. The average easy access savings account pays 2.5% according to Bank of England data. That means many savers don’t have a huge buffer against inflation, even before taking tax into account. And for some, their money will already be going backwards in real terms.”
