Bank of England cuts interest rates to 3.75% and signals further falls

The base interest rate was cut from 4% to 3.75% on Thursday, as Economics Editor Joel Hills reports.

The Bank of England has cut interest rates and signaled that borrowing costs are likely to fall further in 2026.

There was a clear case for the Bank to act: the UK economy is sluggish, unemployment is rising, and prices are stabilizing faster than expected.

The Bank now expects the headline annual rate of inflation, which stood at 3.2% in November, to return to its 2% target sometime between April and June next year - six months sooner than previously forecast.

However, the Bank seems far less certain that inflation will stay there.

Governor of the Bank of England, Andrew Bailey, said: “We’ve passed the recent peak in inflation and it has continued to fall, so we have cut interest rates for the sixth time, to 3.75%, today. We still think rates are on a gradual path downward. But with every cut we make, how much further we go becomes a closer call.”

Since August last year, interest rates have fallen at their fastest pace since the 2008 financial crisis.

But “a closer call” rings a note of caution.

The impact of last month’s Budget is not clear-cut. In the near term, measures such as removing levies from energy bills and freezing rail fares and fuel duty are expected to lower headline inflation by around 0.5 percentage points next April. But these effects are temporary.

The Bank also notes that the Budget may slightly boost growth over the next couple of years, which reduces the immediate need for rate cuts to support the economy.

Ultimately, the Monetary Policy Committee is focused on the horizon, trying to judge where the economy will be in two to three years, by which time the Budget’s effects will probably have faded.

Lower interest rates make borrowing cheaper for households and businesses, encouraging loans for homes, cars, or business investment.

Extra spending boosts demand for goods and services, helping companies grow and hire, which supports jobs and incomes. Lower rates also reduce the cost of existing debt, leaving households and businesses with more money to spend or invest.

Even so, Bank Rate currently remains in “restrictive” territory, meaning it still acts as a brake on activity.

Labour was elected on a promise to revive growth, and the chancellor will be hoping further cuts are on the way.

In a statement, Rachel Reeves said: “This is the sixth interest rate cut since the election - the fastest pace in 17 years, good news for families with mortgages and businesses with loans.

"But I know there’s more to do to help families with the cost of living. That’s why at the Budget we froze rail fares and prescription charges, and will be cutting £150 off the average energy bill next year.”

What happens next will depend largely on the pay settlements companies agree early next year.

Early signs suggest wages in the private sector may rise at a pace that puts upward pressure on prices. By February, the Bank will have a much clearer picture.