LONDON — The Bank of England has significantly reduced its growth forecast for the British economy this year, as it announced a cut to its key interest rate on Thursday, marking the third reduction in just six months. The nine-member Monetary Policy Committee decided to lower the interest rate by 0.25 percentage points, bringing it down to 4.50%. This rate is now at its lowest since mid-2023.
The rate cut was largely anticipated within financial markets; however, the extent to which the Bank scaled back its growth projections took many by surprise. The bank now estimates that the economy will only expand by 0.75% this year, a significant decrease from the earlier prediction of 1.5% made just three months prior. Should this estimate hold true, it would prove to be a considerable letdown for the newly elected Labour government, which is focusing on growth as a critical priority. Economic growth is seen as pivotal to improving living standards and generating revenue for public services, which are currently in need of support. The Labour party’s approval ratings have already seen a decline since their electoral victory as growth has remained elusive.
Treasury chief Rachel Reeves, who faced backlash due to tax increases on businesses in her initial budget last October, expressed approval for the rate cut. Nevertheless, she conveyed that she is “still not satisfied with the growth rate” and emphasized that the government plans to expedite efforts to support economic growth.
The government is likely optimistic that further interest rate cuts from the central bank in the upcoming months will provide much-needed assistance, as this would lead to lower mortgage rates and affordable loans. However, such reductions may also decrease the returns available to savers. Financial markets are uncertain about how many more cuts may occur this year, especially given the Bank’s expectations of increased inflation over the next few months.
Governor Andrew Bailey was cautious in guiding expectations. “We’ll be monitoring the U.K. economy and global developments very closely and taking a gradual and careful approach to reducing rates further,” Bailey stated. He emphasized that maintaining low and stable inflation is essential for a healthy economy and is a core responsibility of the Bank of England.
The recent rate cut reflects growing concerns regarding the economic outlook of the U.K., which has seen minimal growth over the previous six months. Notably, two committee members voted for a more substantial cut of 0.5 percentage points, signaling considerable concern among some policymakers about obstacles to economic growth.
Although the rate-setting committee does not directly target economic growth in its mandate, it aims to achieve a 2% target for inflation, measured by the consumer prices index, over the coming years. Lower growth can play a role in controlling inflation, indicating a decrease in demand within the economy.
Currently, inflation is at 2.5% and is expected to rise in the near future, partly due to recent increases in business taxes by the Labour government. However, many economists project that inflation will gradually decline toward the target, which facilitated Thursday’s rate cut.
While inflation has fallen from its multi-decade highs, after central banks raised borrowing costs from almost zero during the pandemic, prices initially surged due to supply chain disruptions and were exacerbated by Russia’s invasion of Ukraine, inflating energy costs significantly. As inflation rates have retreated, central banks, including the U.S. Federal Reserve, are now lowering interest rates, although few economists anticipate a return to the exceedingly low rates experienced during the aftermath of the 2008-2009 global financial crisis or throughout the pandemic.
