Interest rates cut to 4.25% - what does it mean for cash savings?

Last week, the Bank of England (BoE) lowered interest rates by 0.25% to 4.25%, the fourth cut in ten months. It provides a little more relief for households and businesses with debts to service. Yet the gradual pace of reductions, as well as the split vote among members of the voting committee, highlights the delicate balancing act the Bank has in setting interest rate policy.

There was an unusual three-way divide among the Monetary Policy Committee (MPC), with five of the nine committee members electing for a 0.25% cut. Two members voted for a larger 50 basis-point reduction, but two voted to hold rates where they were.

This reflects the exceptionally cloudy picture around economic growth and inflation, and the wide variety of plausible scenarios. While the BoE lowered the headline rate to help guard against any sharp economic downturn driven by global trade frictions, it did so amid lingering inflationary pressures that were enough for two of the MPC members to vote for a ‘hold’.

A potential growth shock – but not nailed on

The scale and pace of further rate cuts are conditional on the economic outlook. Uncertainty around US trade policy stands to clip the already-weakened wings of UK growth, but much depends on the shape of the trade deal hammered out.

The economic tectonic plates are shifting rapidly with trade ructions and the potential for reverberations across the globe. Yet there has been some relief from the temporary rollback of reciprocal tariffs from the US administration, and the UK could emerge as a relative trade winner once the dust settles, helping shelter businesses and consumers from the worst of the fallout. Indeed, since last Thursday’s BoE meeting a tentative US-China agreement around trade signals the worst tariff fears may not come to pass.

The uncertain landscape makes predicting the strength of UK economic activity and demand very difficult, but we can safely say there is a risk of a downturn that would serve to dampen demand and inflation. In this scenario we can expect policymakers to step in and lower rates further and faster to support the economy – vindicating dissenters among MPC members calling for a jumbo 0.5% cut this time around.

But if growth does hold up thanks to a resilient consumer buoyed by wage rises and healthy savings, the MPC may have to concede inflation is the bigger enemy further down the line. If so, we can expect interest rates to be cut at a far more gradual cadence.

Domestic price pressures aren’t easing yet

The inflation genie is not yet squeezed back into the bottle and domestic price pressures look set to build in the short term. Inflation is anticipated to reaccelerate to well beyond 3% this year, much higher than the BoE target of 2%, amid higher household bills and robust pay growth adding to spending power.

There are also early signs companies are mostly passing on higher national insurance and minimum wage costs to customers, which stands to keep the inflationary embers burning. Ultimately this could balance out any beneficial effects on inflation from tariffs such as cheap Chinese goods being diverted elsewhere, as well as lower oil prices and a stronger pound.

Interesting, the BoE revised its growth forecasts higher again. It expects UK Gross Domestic Product (GDP) to grow by 1% this year, up from a forecast of 0.75% previously, suggesting that economic contraction is a bit less of a risk than it previously thought. An economy that is growing, even very modestly, could tilt the inflationary scales towards higher prices.

However, BoE Governor Andrew Bailey commented that while inflation is expected to rise in the near term, it is not expected to persist. That’s because higher energy and utility prices, as well as the higher National Insurance costs, are expected to be temporary factors that will pass.

When will interest rates be cut further?

The balance of these conflicting forces will dictate how far and how fast the Bank can move on interest rates. Lat week’s cut seems a sensible, precautionary one to help head off a weakening economic picture, and it will continue to cut in a more difficult trade and economic scenario. This would then have the positive effect of reducing mortgage and borrowing costs, and restore some business confidence and consumer spending power in what would be a trickier time for the economy and for households.

But ultimately if inflation numbers remain elevated it won’t be able to ignore them. In this scenario we can only expect a small number of cuts for the remainder of the year.

What does it mean for borrowing and savings rates?

The recent leg down in interest rates was expected and has not had a big impact on fixed rates. Fixed mortgages tend to be priced off ‘swap rates’ which reflect not just where interest rates are today but where they will be over the next couple of years or more. However, borrowers with tracker mortgages will see the benefit of a lower rate passed on quickly.

For cash savings, a gradual downward trajectory in BoE base rate has been expected for some time and savers will have noticed that available interest rates have been getting steadily less attractive. That said, it’s still possible at the time of writing to secure easy access rates of up to 4.1% though Charles Stanley Direct Cash Savings.

Meanwhile, in the fixed rate market there are still some accounts available in the 4.4% range. If you are looking to fix, with at least a couple more interest rate cuts expected before the end of the year it could make sense to take advantage of these while they last. But do remember you can’t withdraw from these before the term ends, so these are only suitable for those who know they don’t need to get at their money within that time frame.

More about Charles Stanley Direct Cash Savings

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To start, open a Charles Stanley Direct account, and open your Cash Savings account from the portal. For an introduction to the service check out this video on our YouTube channel.

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