The Bank of England is set to cut interest rates in its next meeting this Thursday from 4.75% to 4.5%, following lower-than-expected inflation figures for December but ongoing concerns about sluggish economic growth.
Markets are pricing in a 90% probability of a rate cut, marking the third reduction in borrowing costs since the peak of 5.25% in August 2023.
Susannah Streeter, head of money and markets, Hargreaves Lansdown (HL.L), said: “The scene has been set for a rate cut next week, with December’s dip in inflation and the flatlining economy taking centre stage.
"Three policymakers wanted to see a rate cut at the last meeting to boost growth, and it’s looking highly likely that more will follow their lead next Thursday and vote for a reduction."
While the likelihood of a rate cut appears strong, some City traders cautioned that the Bank of England’s ability to lower borrowing costs further could be constrained by rising inflationary pressures.
Laith Khalaf, head of investment analysis at AJ Bell, said: “This will be the first interest rate decision from the Bank of England in 2025, and chances are we’re going to start the year off with a cut to base rate.
"Economic signals have been weak and services inflation has fallen back substantially since the last meeting of the MPC [monetary policy committee] in December, at which point three members of the committee already voted for a cut to 4.5%.
“The market is currently pricing in a 90% chance of a rate cut and that feels about right. There’s the possibility of a surprise, but a small one.”
Although inflation has decreased significantly from its peak above 11% in mid-2022, driven by the energy price surge following Russia’s invasion of Ukraine, it has remained above the BoE's 2% target. Analysts anticipate it could surpass 3% within months.
Michael Field, European market strategist at Morningstar, said: “The chances seem high for a cut on 6 February, with much of this optimism being based on the most recent inflation figure. To me, these inflation moves are very marginal. Ultimately, with rates in the UK at 4.75%, that seems excessively high, particularly given how far inflation has already fallen from the peaks".
Deutsche Bank anticipates that Catherine Mann, a known ‘hawk’ on the MPC, will be the only member to dissent against a rate cut. Sanjay Raja, chief UK economist at the bank, said: “A quarter-point rate cut to 4.5% remains our base case. With growth slowing, unemployment rising and services inflation sinking below the Bank’s forecasts, a February rate cut seems all the more likely.
“We expect a 8-1 vote tally for a rate cut, with Catherine Mann the lone dissenter.”
However, despite the almost certainty that Threadneedle Street will cut rates in its next meeting, investors aren’t as confident about what to expect next.
Markets are currently pricing in just two or three more cuts this year, taking the base rate from 4.75% to 4%. However, Morgan Stanley has a more aggressive outlook, forecasting five rate cuts in 2025, bringing the base rate down to 3.5%.
The analysts at the investment bank stated: “We still expect the cut in February, and bank rate at 3.5% by year-end. We now expect cuts in February, May, June, August and November.”
Goldman Sachs shares a similarly dovish view, predicting that rates will fall to 3.25% by June 2025. “A cut on 6 February is very likely and largely priced by financial markets.
“But we believe that markets are pricing too few rate cuts beyond that relative to our bank rate forecast of 3.25% in the second quarter of 2026.”
What does this mean for my mortgages?
The Bank of England’s anticipated rate cut will affect millions of households across the UK, particularly those with mortgages, credit cards and savings accounts.
According to the government’s English Housing Survey, nearly one-third of households have a mortgage, and approximately 600,000 homeowners have mortgages that "track" the Bank’s base rate. For those individuals, a rate cut would lead to immediate reductions in monthly repayments.
Sarah Coles, Yahoo Finance UK columnist and head of personal finance at Hargreaves Lansdown (HL.L), said: “If you’re on a fixed-rate mortgage, the rate cut won’t affect you immediately because it’s already priced into the market.”
As of January, the average two-year fixed-rate mortgage has risen slightly from 5.48% to 5.52%, and it may decrease a little in the coming days. However, for those on variable or tracker mortgages, a rate cut could result in a decrease in monthly payments.
How will this impact my savings?
For savers, the rate cut could result in lower returns on savings accounts. Mark Hicks, head of active savings at Hargreaves Lansdown (HL.L), explained: “With the base rate widely expected to be cut next week, a lot of the reductions have already been priced into savings products.
"Those providers that are paying above base rate on easy access savings will have to reduce their rates as a result of the cut, in order to ensure they don't operate loss-making products.
“As a result, the easy access market will come under a bit of pressure, with very little change expected in fixed terms. The cash ISA market remains incredibly competitive, with multiple providers still paying around or slightly above 5%.
"As we head towards the end of the tax year, it will be interesting to see if these providers can keep paying these rates, given they will likely already be operating them at a loss. The biggest driver will be if the market starts to price in more than three rate cuts over the medium to long term.”
What about my pension?
The prospect of a rate cut doesn’t seem to be impacting annuities, which remain robust despite the BoE's likely move.
Helen Morrissey, Yahoo Finance UK columnist and head of retirement analysis at Hargreaves Lansdown (HL.L), warned: “Annuities are riding high, and not even the prospect of an impending rate cut seems able to burst their bubble.”
Currently, those purchasing an annuity with a £100,000 pension at age 65 can expect to secure up to £7,492 per year from a single life level annuity with a five-year guarantee, just under the record highs seen after the mini-budget.
What are the US Federal Reserve and the ECB doing?
This follows on from a hawkish rate cut in December, where Fed officials upgraded their inflation forecasts and only signalled two further cuts in their plan for 2025, which was fewer than expected.
The market is pricing in two rate cuts by December as projections for inflation have remained elevated.
In Europe, The European Central Bank (ECB) has cut interest rates by a quarter-point, as expected, in an effort to support economic growth and tackle stubborn inflation. After lowering key rates again in December, the benchmark rate on deposit facility has now fallen from 3% to 2.75%, its lowest level since early 2023.
The ECB lowered borrowing costs four times last year, with four moves anticipated in 2025, according to the swaps market.
The Bank of England will announce its decision this Thursday at noon.
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