Yes! Mortgage rates will fall next year – unless
It’s been a very bumpy few months – swap rates have risen, first lenders cut then they raised – and then some cut and… Well, you were there in the mortgage market – you saw. But in what may be a piece of very good news, The Bank of England looks like it is poised to cut interest rates four times next year, provided its economic forecasts prove accurate. Governor Andrew Bailey speaking at a Financial Times event yesterday hailed the recent drop in inflation as a promising sign for the economy, and said we should expect good news – depending on one important budget factor.
Speaking at the Financial Times Global Boardroom conference, Bailey observed that inflation had fallen more sharply than policymakers had predicted a year ago. While the Bank does not issue explicit interest rate forecasts, unlike the Federal Reserve in the United States, its predictions for inflation and economic growth are guided by market expectations for interest rate movements.
Addressing investor assumptions included in the Bank’s November projections, which anticipate four quarter-point reductions over the next year, Bailey explained: “We always condition what we publish in terms of the projection on market rates, and so as you rightly say, that was effectively the view the market had.”
Asked whether the Bank’s central scenario for 2025 would involve around four rate cuts, he simply replied: “Yup.” He added, “We’ve been looking at a number of potential paths ahead — and some of them are better than others.”
UK inflation has fallen sharply from a peak of 11.1 per cent in late 2022, with October figures showing price growth at 2.3 per cent, slightly above the Bank’s 2 per cent target. Despite this, the Bank has indicated it will tread carefully with further reductions to borrowing costs, mindful of persistent inflation in the services sector. This year, the Bank has already trimmed its key rate twice, leaving it at 4.75 per cent.
Mr Bailey emphasised that while various inflation scenarios remain possible, the Bank’s most recent monetary policy report points towards a “gradual” approach to reducing interest rates.
His comments coincided with an OECD report warning that our mortgages may stay elevated longer than those overseas - the Bank of England is unlikely to lower rates as much as the Federal Reserve or the European Central Bank, due to the UK’s slower growth and more stubborn inflation.
According to the OECD, UK interest rates are expected to settle at 3.5 per cent by 2026, slightly above the Fed’s projected terminal rate of 3.25–3.5 per cent. The ECB’s rate, by contrast, is forecast to fall to 2 per cent by late 2025.
The OECD also expects the UK economy to grow by 1.7 per cent in 2024 and 1.3 per cent in 2026, following an estimated 0.9 per cent expansion this year, despite tax rises in the Autumn Budget. However, inflation in Britain is predicted to remain more persistent than in other G7 nations, increasing slightly to 2.7 per cent in 2025 before easing back to 2.3 per cent in 2026.
Álvaro Pereira, the OECD’s chief economist, said the slower pace of rate cuts expected from the Bank reflected strong domestic demand and additional fiscal stimulus announced in Chancellor Rachel Reeves’ Budget, which eased previous fiscal constraints. “Some strong but not spectacular wage growth” also reduces the need for swift rate reductions, he observed.
The OECD highlighted positive momentum in the UK economy, driven by increased government spending. However, it warned that headline inflation would remain above target through 2025 and 2026, owing to persistent price pressures and heightened demand.
In his remarks, Mr Bailey outlined three possible scenarios for UK interest rates. In the most optimistic case, disinflation would be “well embedded,” paving the way for faster cuts. A less favourable outlook envisaged structural changes in the economy, leading to persistent inflation and requiring tighter monetary policy. The “central view,” Mr Bailey noted, suggests the Bank will need to “lean in a bit harder” to keep inflation under control, resulting in slower rate reductions.
The Bank’s November forecasts are underpinned by market expectations for four rate cuts next year, although current pricing in swap markets suggests only three reductions by the end of 2025.
Reflecting on the success of the UK’s inflation-targeting framework, Mr Bailey remarked: “[Inflation] has come down faster than we thought it would. I mean, a year ago we were saying that inflation today would be around 1 per cent higher than it actually is. That, I think, is a good test of the regime. The regime could never stop these shocks happening.”
The OECD report also called for “prudent” fiscal management, highlighting public debt levels above 100 per cent of GDP and rising. “With limited fiscal buffers, possible external shocks that would require fiscal support are a significant downside risk to the outlook,” it cautioned. It added that sustained government spending and uncertainty over the degree of slack in the labour market could necessitate tighter monetary policy for longer.
And the big ‘but’ in all of this is what effect the recent Labour government’s National Insurance hike will have, with Bailey saying that this was the “biggest issue in the immediate future”.
“How companies balance the mixture of prices, wages, the level of employment, what is taken on margin, is an important judgement for us,” he explained.
