Chancellor’s hopes of a quick fiscal tonic raised by votes for larger interest rate cuts

The Bank of England’s decision to cut interest rates from 4.75 to 4.5 per cent was expected, but two votes for even larger cuts were not. This suggest rates may come down more quickly than had previously been expected, raising the Chancellor’s hopes of lower debt servicing costs that could help the UK’s fiscal position, the Resolution Foundation said today (Thursday).

As well as cutting rates, the Bank delivered a downbeat assessment on growth. It has revised down its GDP outlook for 2025 by 0.9 percentage points to 0.6 per cent. The Bank’s forecast suggests a 40 per cent chance that the economy will shrink in the year to Q2 2025 – raising the risk of recession.

Upward revisions to inflation over the coming months hint at the risk of stagflation. The Bank now expects inflation to rise to 3.7 per cent in Q3 2025, well above its November forecast of 2.8 per cent. This is driven by higher energy prices which are particularly damaging for lower-income families: spending in this area makes up a tenth of monthly spending for the poorest fifth of households, twice that of the richest fifth.

The votes of MPC members hint that interest rates may be cut more quickly this year than expected before today’s decision. Indeed, market expectation of medium-term interest rates fell in the immediate aftermath of the publication of the Monetary Policy Report. If this happens, it should lower the UK’s debt servicing costs – a sustained fall in interest rates of 1 percentage point will reduce borrowing by around £17 billion.

Lower market expectations should also reduce mortgage costs for the 1.2 million households rolling off fixed rate deals this year. However, the roughly 570,000 households rolling off cheap five-year fixes secured in 2020 are unlikely to feel much cheer, as their annual costs are set to rise by more than £2,500 a year, on average.

James Smith, Research Director at the Resolution Foundation, said:

“Last week the Chancellor set out her plan to boost growth over the next decade, but today the Bank has said it expects to see next-to no growth over the coming months.

“The upcoming energy prices-led spike in inflation could prove painful for low-income families, who spend around a tenth of their budgets on these bills.

“The Bank’s downbeat assessment may however contain a silver lining for the Government and mortgage holders. The MPC may quicken the pace of interest rates cuts this year, reducing debt servicing costs to give the Chancellor some much-needed headroom, and reducing rates for those looking to remortgage this year.”