UK interest rates cut by 0.25% in first reduction for four years

Bank of England reduces the cost of borrowing from 5.25% to 5%

The Bank of England in London. It has cut interest rates from 5.25% to 5%. AP

The Bank of England has cut UK interest rates by 0.25 per cent to 5 per cent, the first downward movement to rates since March 2020.

The move comes after the bank’s Monetary Policy Committee (MPC) had kept interest rates at a 16-year high for almost a year.

Headline inflation in Britain had met the Bank of England’s 2 per cent target in May and June, and despite some economists noting inflation in the services sector was still running at 5.7 per cent in June, the MPC opted to reduce interest rates.

The US Federal Reserve left interest rates on hold at 5.25-5.5 per cent on Wednesday, but indicated that a cut would come in September.

Members of the MPC voted 5-4 in favour of the rate cut.

Bank of England governor Andrew Bailey, along with Sarah Breeden, Swati Dhingra, Clare Lombardelli and Dave Ramsden voted in favour, while Megan Greene, Jonathan Haskel, Catherine Mann and Huw Pill voted to maintain the rates at 5.25 per cent.

"The key element behind the decision to cut is possibly the replacement of [Ben] Broadbent by new MPC member Lombardelli, who has today voted to cut rates, while Broadbent was previously in the camp keeping rates on hold," said Stuart Cole, chief macroeconomist at Equiti Capital.

"It does raise the question that interest policy is decided just as much by who you put on the MPC as by the data itself."

Nonetheless, Mr Bailey said inflationary pressures had "eased enough that we've been able to cut interest rates today".

He added that MPC members needed to "make sure inflation stays low and be careful not to cut interest rates too quickly, or by too much".

Andrew Bailey, governor of the Bank of England, said policymakers must 'make sure inflation stays low and be careful not to cut interest rates too quickly, or by too much'. Reuters

'Mixed evidence'

UK interest rates rose quickly from late 2021 to a peak of 5.25 per cent in August last year, before remaining there for 12 months.

The British pound dropped 0.7 per cent against the US dollar and 0.3 per cent against the euro directly after the rate announcement.

Alpesh Paleja, interim deputy chief economist at the Confederation of British Industry, noted the tightly split vote suggests "mixed evidence that inflation persistence has been defeated".

“We still think that today’s meeting marks the start of a rate-cutting cycle, but the pace of this is now more uncertain," he said.

"Several MPC members will be looking for more definitive signs of inflation persistence easing, to be swayed towards reducing rates further."

As such, economists are now speculating on the timing and direction of the next move to interest rates.

"Inflation has the potential to nudge upwards later in the year when declines in energy prices in 2023 fall out of the annual comparison, while Chancellor Rachel Reeves’s public-sector pay rises could also have an inflationary effect, so the Bank of England may be cautious on the timing of its next rate move," said Alice Haine, personal finance analyst at Bestinvest by Evelyn Partners.

For Ruth Gregory, deputy UK economist at Capital Economics, the Bank of England will reduce rates more significantly than many are forecasting over the next 12 months.

"We still think that a fading in services inflation and below-target CPI inflation will prompt the bank to cut rates to 4.50 per cent by the end of this year and 3 per cent next year, rather than 3.75 per cent as markets expect," she said.

"That said, if we are wrong it’s likely to be because rate cuts are slower and smaller than we currently expect."

However, Anna Leach, chief economist of the Institute of Directors, is not expecting much in the way of rate cuts for the rest of this year.

"With wage growth and services inflation still high, and headline inflation expected to rise in the coming months, monetary policy is set to stay restrictive for a good while yet,” she said.