The UK could face a longer wait for interest rate reductions following the Bank of England’s prediction that inflation will rise after last week’s Budget.
The Bank noted that while the increased spending will initially stimulate economic growth and reduce unemployment, measures like raising the cap on bus fares and VAT on private school fees are likely to accelerate inflation.
As expected, the Bank has cut interest rates to 4.7% from 5%. However, Bank Governor Andrew Bailey indicated that while rates may continue to decrease gradually, they cannot be lowered “too quickly or by too much.”
Investors now anticipate no further rate cuts this year, with the Bank expected to maintain rates at its December meeting.
Though inflation, which tracks the rate of price increases, dipped below the Bank’s 2% target in the year leading up to September, it was predicted to rise again due to recent hikes in gas and electricity prices.
Previously, inflation was expected to return to 2% by 2026, but the Bank now forecasts this will happen a year later.
The Bank’s interest rate significantly impacts the rates that High Street banks and other lenders offer on loans and credit cards.
Over a million mortgage borrowers with tracker and variable-rate mortgages are likely to see an immediate decrease in their monthly payments.
However, mortgage rates remain much higher than they have been over the past decade, with the average two-year fixed rate at 5.4% and a five-year deal averaging 5.11%, according to Moneyfacts.
This latest rate cut also suggests that savers may see lower returns from banks and building societies, with the current average rate for an easy access account around 3% annually.
Chancellor Rachel Reeves, said: “Today’s interest rate cut will be welcome news for millions of families, but I am under no illusion about the scale of the challenge facing households after the previous government’s mini-budget.”
The timing and magnitude of future rate cuts could be influenced by the additional growth and inflation generated by last week’s Budget.
The Labour government’s Budget outlined plans to borrow an extra £28bn annually, alongside £40bn in tax-raising initiatives. The most significant measure is an increase in National Insurance Contributions (NICs) paid by employers.
The Bank of England noted that this would have a minor effect on inflation, as businesses are expected to pass on the increased NIC costs to customers through higher prices. This could also lead to a slower pace of wage growth for employees.
Additionally, the Bank revised its growth forecast for 2025 upwards and suggested that the unemployment rate could decrease sharply, from 4.7% to 4.1%.