Bank of England Cuts Interest Rates to 4.5% Amid Economic Uncertainty

On February 6, 2025, the Bank of England announced a 0.25 percentage point reduction in its base interest rate, bringing it down to 4.5%. This decision marks the third rate cut in six months and reflects the central bank’s response to a stagnating economy and persistent inflationary pressures. The Monetary Policy Committee (MPC) voted 7-2 in favour of the reduction, with two members advocating for a more substantial cut.

Economic Context and Rationale

The UK economy has exhibited weaker-than-expected growth since March 2024, prompting the Bank of England to halve its 2025 growth forecast from 1.5% to 0.75%. At the same time, inflation is anticipated to rise to 3.7% by the third quarter, driven by higher energy prices and increased government-regulated household bills. An uptick in national insurance contributions has also contributed to a forecasted rise in unemployment to 4.8%.

In this context, the rate cut aims to stimulate consumer spending and ease financial conditions. However, the central bank cautions that inflation is expected to return to its 2% target only by the end of 2027, indicating a prolonged period of economic adjustment.

Market Reactions

The financial markets responded notably to the rate cut. The FTSE 100 index surged to a new all-time high, closing at 8,727.28 points—a 1.1% increase. This rise reflects investor optimism, as lower interest rates typically reduce borrowing costs for companies and can boost corporate profits.

Conversely, the pound depreciated against major currencies, and short-term government bond yields declined. These movements suggest that investors anticipate further rate cuts and a potentially prolonged period of accommodative monetary policy.

Housing Market Implications

The housing market stands to be directly impacted by the rate cut. Lower interest rates often lead to reduced mortgage rates, making borrowing more affordable for prospective homeowners. Following the Bank’s announcement, several major lenders, including Barclays, HSBC, and Nationwide, announced reductions in their mortgage rates.

However, while lower rates can stimulate housing demand, they may also contribute to higher property prices, potentially offsetting the affordability benefits for first-time buyers. Additionally, those with existing fixed-rate mortgages may not immediately benefit from the rate cut.

Inflationary Concerns and Future Outlook

Despite the rate reduction, the Bank of England remains vigilant regarding inflation. Chief Economist Huw Pill emphasised that the institution cannot rapidly cut interest rates due to persistent inflationary pressures. He noted that borrowing costs must remain sufficiently high to address these concerns, suggesting a cautious approach to future rate adjustments.

Governor Andrew Bailey echoed this sentiment, indicating that while further rate cuts are possible, they will be approached gradually to avoid undermining progress in controlling inflation. He also highlighted external factors, such as potential global trade tensions, that could influence the UK’s economic trajectory.

Political and Fiscal Considerations

The rate cut occurs within a complex political and fiscal landscape. The Labour government, which has prioritised economic growth to improve living standards and public services, faces challenges as its popularity wanes due to stagnant growth and higher business taxes. Treasury Chief Rachel Reeves supported the rate cut but emphasised the need for faster economic stimulus.

Additionally, global factors, such as potential trade tensions stemming from U.S. tariff policies under the Trump administration, add layers of uncertainty to the UK’s economic outlook. The Bank of England has acknowledged these external risks, underscoring the importance of a cautious and measured approach to monetary policy.

Conclusion

The Bank of England’s recent interest rate cut to 4.5% reflects its efforts to navigate a challenging economic environment characterised by sluggish growth and persistent inflation. While the reduction aims to stimulate economic activity, the central bank remains cautious, balancing the need for growth with the imperative to control inflation. As the UK economy faces both domestic challenges and external uncertainties, the path forward will require careful calibration of monetary policy to foster sustainable economic health.