Bank of England cuts interest rates to 5% in first reduction since March 2020

The Bank of England recently lowered interest rates for the first time since the beginning of the Covid pandemic. This decision was made in order to help reduce the financial burden on families, as borrowing costs had been increased to address the highest inflation levels seen in forty years.

After maintaining borrowing rates at their highest levels since the financial crisis of 2008 for one year, the Bank's monetary policy committee (MPC) made a carefully considered decision to lower the base rate by 0.25% to 5%. This decision was reached by a small majority of the committee members.

Revealing disagreements among the top officials of the central bank regarding when to lower interest rates, the Monetary Policy Committee (MPC) was divided with five members voting in favor and four members voting against. The governor, Andrew Bailey, ultimately made the final decision to cut borrowing costs for the first time since March 2020.

The Bank of England kept headline inflation steady at 2% for the second month in a row in June. This led to expectations in the financial markets for a rate cut, although there were concerns among City economists about the possibility of high inflation becoming a long-term issue. As a result, the pound weakened against the US dollar and euro when interest rates were reduced to 5%.

Bailey noted that the inflationary pressures had decreased sufficiently to allow for the first cut in borrowing costs since the Bank stopped increasing interest rates a year ago. This is the longest period that rates have remained steady following a cycle of increases since the year 2000.

Still, Bailey mentioned that individuals saving and taking out loans should not anticipate significant decreases in the near future. He expressed worry about the potential risks still present in the economy. Bailey emphasized the importance of keeping inflation at a low level and cautioned against rushing to lower interest rates too quickly or by too large of an amount.

Making sure that inflation stays low and steady is the most effective way to help the economy grow and ensure the country's prosperity.

Threadneedle Street, also known as the Bank of England, is beginning to relieve the financial burden on families during the current cost of living crisis. This positive development follows a significant drop in inflation this year. It will be a promising move for the recently elected Labour government led by Keir Starmer, who is focused on improving stalled living standards and the sluggish economy.

Rishi Sunak and Jeremy Hunt, who were previously in charge of the economy as the Conservative leader and shadow chancellor, will likely highlight this as proof that their efforts were starting to pay off. Unfortunately, this progress came too late to help the former prime minister, who had hoped that decreasing inflation would improve his chances in a sudden general election.

Hunt shared on X: "While in office, we made tough choices that brought inflation down from 11.1% to the Bank's desired 2%, making it possible to lower interest rates. Unfortunately, we are worried that future significant cuts might be delayed due to the chancellor approving public sector pay increases that could fuel inflation before the summer."

On the other hand, Bailey had a different opinion. During a press event, he mentioned that increases in public sector salaries would not have a significant effect on inflation. He stated, "The Bank of England looks at private sector pay as it has a direct impact on the consumer price index (CPI) inflation."

Bailey mentioned that the Bank is still unsure about the complete effects of the pay settlement since it is unclear how the recent salary boosts for NHS workers and teachers will be financed. However, he estimated a minimal inflationary impact based on a rough calculation.

In a recent statement, Chancellor Rachel Reeves expressed gratitude for the decrease in rates announced on Thursday. However, she pointed out that many families are still dealing with increased mortgage rates following the recent economic update. She refuted claims that the rate cut was a result of the decisions made by the Tory government, emphasizing that interest rate choices are made independently by the Bank of England. Despite this, she highlighted the challenges of managing a £22 billion deficit in the public budget.

Following a consecutive streak of 14 rate hikes starting from a historically low 0.1% in December 2021, people and businesses throughout the UK were feeling the strain of increased mortgage payments due to the central bank's reaction to soaring inflation rates not seen since the early 1980s. Inflation reached its peak at 11.1% in October 2022 following the Russian invasion of Ukraine, which caused a sharp spike in energy costs.

The rate of inflation has decreased to the government's target of 2% in the past few months. However, prices are still much higher than they were three years ago and continue to go up. Even though the impact of increasing energy costs has started to lessen, the Bank of England is worried about the steady increase in prices in the service industry and the strong growth in wages.

The MPC barely decided to decrease rates and cautioned that the headline inflation was expected to increase to approximately 2.75% in the coming months, exceeding its goal. Nevertheless, the Bank predicts that inflation will decrease to around 1.7% in two years, then further drop to 1.5% in 2027.

The Monetary Policy Committee (MPC) stated that there were various possible outcomes for inflation that could occur: either a sustained decrease in inflation due to significant borrowing costs affecting the economy and job market, or a situation where inflation remains high for an extended period if economic activity continues to be stronger than expected.

The economy of Britain has expanded more quickly than expected in recent months, coming out of a period of recession in the first quarter with a growth rate of 0.7% - which is twice as much as the growth rates seen in France and Germany. Although there was no growth in April, the economy grew at a higher rate than expected in May.

The Bank projected that the economy would see slower growth of around 0.25% in the near future. They also cautioned that unemployment is likely to increase next year. This justified their decision to lower interest rates for the first time since the start of the Covid pandemic.

Raising concerns about their future choices, the MPC cautioned that their policy position would stay at "restrictive" levels, impacting economic activity even after lowering interest rates. They stated that monetary policy would need to remain restrictive for a considerable amount of time until the risks of inflation reaching the 2% target in the medium term have decreased.