Why interest rates are likely to be cut after the Budget

The small drop in the inflation rate – from 3.8 per cent to 3.6 per cent – announced on Wednesday morning is the latest indication that a fourth interest rate cut of the year is expected before the end of 2025.

The Bank of England’s Monetary Policy Committee voted to hold rates at 4 per cent at the start of November, but there is one final vote to come in 2025 – on 18 December.

While the BoE governor Andrew Bailey spoke of wanting to see more data before committing to further cuts, the confirmation that inflation has eased slightly is the latest, and biggest, indicator that a rates cut is required to get the economy moving once more.

There is one more major event on the horizon before the vote: Rachel Reeves’ Budget. But expectations are for this to be similarly disinflationary, meaning a rates cut appears almost a certainty.

After two months at 3.8 per cent – September’s data was lower than the 4 per cent expected – we’ve now seen inflation drop back to the level last seen in June, confirming analysts’ expectations that inflation has peaked. One slight concern will be over food prices, which are rising again after a one-month drop. The Food and Drink Federation noted that “manufacturers are paying nearly 40 per cent more for ingredients and energy than they were in January 2020”, explaining the huge uptick in prices. But the wider inflationary picture points to a rates cut.

It’s not just inflation that the BoE look to though, and elsewhere the signs also show that a kickstart is needed.

The housing market has been far from firing on all cylinders, with many industry experts noting that buyers and sellers alike are holding off for more certainty around any tax implications, given the past few months has seen everything from reports over a Mansion Tax to the Conservatives claiming they would eliminate stamp duty altogether – a move backed by Kirstie Allsopp.

More recently, economic data showed the UK’s GDP growth slowing to just 0.1 per cent across the past three months, with production output in particular dropping.

Factor in job vacancies falling to the lowest level of the year and the rate of unemployment hitting 5 per cent for the first time since Covid and it’s clear that businesses are no longer investing to the levels required, just as much as people are not moving or spending as much as needed.

Given the factors highlighted above, it would have been unsurprising had the BoE pre-empted some of that most recent data by cutting rates on 6 November. Indeed, they almost did – the vote was split 6-5, with governor Bailey casting the deciding vote to stick rather than twist.

Perhaps the biggest reason behind that apparent caution was the Budget, and the lack of clarity over what to expect.

That said, tax rises on individuals and more costs for businesses are generally disinflationary.

“The upcoming Budget is likely to involve measures specifically designed to push down on inflation in things like energy prices, while the overall degree of fiscal consolidation is also likely to weigh on growth and inflation in the medium term,” explained Luke Bartholomew, an economist at Aberdeen.

As noted though, it’s not totally clear what’s coming and any surprises could still have the opposite effect.

“If Rachel Reeves’ upcoming Budget includes policies which could be seen as inflationary, then those rate setters might decide they need to take a bit more time to see exactly how the economy deals with the chancellor’s measures,” cautioned Danni Hewson, AJ Bell’s head of financial analysis. “It’s also notable that the ONS points to a rise in factory gate prices, as many producers as well as retailers seek to offset costs from government measures such as the increase to employer National Insurance payments.

“A fall in inflation for the first time since March is good news but at what is the most expensive time of year for many families, it might not feel like it. Next week’s set piece fiscal event needs to deliver more than just savings for the Treasury.”

It’s important for households to remember that interest rates are a see-saw: while lowering them is good for lower mortgage or debt repayments that are not fixed, it also means less interest earned on savings.

Therefore the first port of call should be to ensure cash savings are in the best-earning accounts whenever possible.

Mortgage rates have been coming down over the past few weeks, but if you’re one of the hundreds of thousands due to renew in the final months of 2025, experts do not recommend waiting for interest rate cuts. This is because products are priced off swap rates – future expectations of interest rates – rather than current rates themselves, so will be priced in already. With many lenders now having sub-4 per cent deals in place, it’s wise to act earlier.

And for businesses, while interest rate cuts tend to encourage investment and hiring, the Budget will again impact more here. The British Chambers of Commerce has repeatedly called for no more tax burdens on firms – and a recent study showed half could be set to raise prices if the Budget pushes up the cost of hiring, which could of course mean another period of rising inflation.

Source: UK Politics - www.independent.co.uk