Bank of England cuts UK interest rates to 4%

Times

5 days ago

Rachel Reeves has been handed another economic headache after the Bank of England warned that inflation will scale to a near three-year high as it signalled that further interest rate cuts could be off the table.
The sobering economic forecast by the central bank on Thursday projected that inflation would hit 4 per cent in September, raising the prospect of steep benefit and pension settlements before the chancellor's autumn budget.
Andrew Bailey, the Bank governor, said that the path towards further cuts to UK borrowing costs was shrouded in 'genuine uncertainty' amid the threat of a renewed cost of living crisis in part fuelled by the government's £25 billion payroll tax rise pushing up food prices. Bailey added that future interest rate decisions would 'need to be made gradually and carefully'.
On Thursday, the Bank's monetary policy committee (MPC), the nine-member group that sets the base rate of interest every six weeks, voted 5-4 in favour of lowering borrowing costs by 0.25 percentage points to 4 per cent, the lowest level in over two years.
However, the ultimate decision required two votes after an initial ballot was inconclusive, a development that shocked investors and prompted them to predict an outside chance of rates staying at 4 per cent.
Rob Wood, chief UK economist at Pantheon Macroeconomics, a consultancy, said: 'The vote was tighter than assumed, the committee's inflation forecasts were stronger and their commentary was more cautious. We remain comfortable assuming that the MPC will hold rates for the rest of this year.'
Thomas Pugh, chief economist at RSM UK, another consultancy, said the hawkish rate announcement 'raises the chances that the MPC chooses to 'skip' a cut' in the final months of the year.
In response to the rate announcement, Reeves said: 'This fifth interest rate cut since the election is welcome news, helping bring down the cost of mortgages and loans for families and businesses.
'The stability we have brought to the public finances through our Plan for Change has helped make this possible and helped us become the fastest growing economy in the G7 in the first quarter of this year.'
Economists have calculated that the chancellor needs to bridge a £30 billion fiscal deficit at the budget with tax increases or spending cuts.
Government borrowing costs rose after the rate announcement and the pound strengthened by 0.5 per cent against the dollar to $1.34. The FTSE 100 fell by 0.69 per cent.
It was the first time the MPC required two ballots to reach a majority rate decision since its inaugural vote in 1998 after the Bank of England was given independence by the chancellor at the time, Gordon Brown.
The Bank said the near-term rise in inflation will be mainly driven by higher food and energy prices and rising household utility bills. The employers' national insurance contributions raid and 6.7 per cent increase in the minimum wage represented 'material increases in labour costs [that] are likely to have pushed up food prices', the Bank said.
Reeves is likely to face fresh fiscal challenges in the form of steep increases to the state pension and welfare payments. September's inflation rate is used to set the triple-lock pension changes and benefit settlements.
The economy was forecast to expand by 1.25 per cent this year, a slight upgrade from the Bank's previous forecast in May. GDP would then increase by 1.25 per cent next year and 1.5 per cent in 2027, the Bank said. Unemployment is set to peak at 4.9 per cent, up from the current 4.7 per cent which is already a four-year high.
Officials at the Bank also warned of a 0.2 per cent hit to the economy over the next three years due to President Trump's tariffs, despite Sir Keir Starmer reaching a trade agreement with the United States in May.
A return of the intense financial market volatility seen after Trump's 'liberation day' tariffs could wipe a further 0.2 per cent off Britain's GDP, the Bank said. However, there may be downward pressure put on inflation from countries rerouting goods originally bound for America to the UK.
MPC members voting for a quarter-point reduction, who included the governor, thought there had been enough progress on inflation in recent months and that a cut was required to counteract higher unemployment, increased staff layoffs and sluggish consumer spending.
Alan Taylor, the external MPC member who initially backed a larger rate cut before changing his vote in the second ballot, thought there was an 'increased' recession risk that warranted a quicker loosening of monetary policy.
The four members of the MPC who wanted to leave rates unchanged at 4.25 per cent, including Huw Pill, the Bank's chief economist, were concerned that companies and workers were engaged in a cycle of high wage demands and price increases. This group wanted to see more data proving that inflation was on a downward path before backing further cuts.
The Bank said that 'monetary policy is not on a preset path'.
Packaging levy 'will push up food inflation'
Food inflation will be pushed up by businesses having to pay a packaging levy to fund recycling, a requirement first enacted by the previous Conservative government and maintained by Labour.
The Bank of England said on Thursday that food inflation would be 0.5 percentage points higher as a result of businesses being required to pay for the disposal of product packaging in a more environmentally sustainable fashion.
The new waste management framework, known as the extended producer responsibility (EPR) but more commonly the packaging levy, was introduced in the Environment Act 2021 under Boris Johnson's government. The Labour government set out final details of the initiative in June.
Some estimates have suggested that firms would have to pay between £130 and £330 to recycle a tonne of glass.
• Wine prices up 9p a bottle thanks to net-zero 'glass tax'
Under the EPR, the cost of packaging waste management transfers from local government to the businesses that produce the packaging. It aims to discourage the use of packaging and encourage more recycling among businesses. A similar scheme will come into force in the European Union in August 2026.
The Bank said that the changes would push up food inflation by half a percentage point, partly driving the rate to a peak of around 5.5 per cent by the end of the year. Food inflation hit 4.5 per cent in the year to June, the highest since February 2024, according to the Office for National Statistics.
'Because packaging costs represent a higher share of food and drinks costs compared with many other goods, the packaging levy is expected to affect CPI inflation mostly via food prices,' the Bank said in its quarterly monetary policy report.
The Bank said that other government policies, such as the £25 billion increase in employers' national insurance contributions (NICs), would put additional upward pressure on grocery inflation and damage the labour market.
'Overall labour costs of supermarkets are likely to have been disproportionately affected by the lower threshold at which employers start paying NICs, in part because a relatively high proportion of supermarket staff is employed part-time', the central bank said.
In April the main rate of employer NICs rose to 15 per cent from 13.8 per cent and the earnings threshold that triggers the levy fell to £5,000 from £9,100, representing a £25 billion increase in taxes paid by the private sector. In the same month the minimum wage rose by 6.7 per cent.
'These material increases in labour costs are likely to have pushed up food prices,' the Bank said.