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Bank of England to cut interest rates to three per cent in 2025 after inflation drops

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"Although the fall in headline inflation is very good news, it is not informative about what we really care about: what we really care about is the persistent and the underlying inflation," Haskel told the Financial Times.
"Although the fall in headline inflation is very good news, it is not informative about what we really care about: what we really care about is the persistent and the underlying inflation," Haskel told the Financial Times.

Interest rates could fall to as low as three per cent next year as the Bank of England slashes the cost of borrowing in response to lower inflation, according to new forecasts.

Economists at Capital Economics, a consultancy, think the Bank will likely have to cut interest rates much faster than markets expect in response to plummeting inflation.

“The UK is on the cusp of switching from having a bigger high inflation problem than other major economies to having a bigger low inflation problem,” they said.

Having peaked at over 11 per cent in October 2022, inflation has fallen dramatically due to much lower food and energy costs. Figures out last week showed that it dropped to 3.4 per cent in February.

Economists expect it will fall to the two per cent target in April thanks to Ofgem’s energy price cap.

While there is some debate about what will happen in the remainder of the year, Capital Economics forecast inflation to go as low as 0.5 per cent in 2024. Inflation will then remain below two per cent for all of 2025 and 2026 as the UK’s economic weakness prevents any rebound in prices.

“The legacy of the weak economy over the past year and the loosening in the labour market will probably prompt businesses in the services sector to raise their wages and selling prices more slowly,” they argued.

“We think investors will be caught out by how far the Bank of England cuts interest rates,” Capital Economics concluded.

In new forecasts released today, economists at KPMG also predicted that interest rates would fall to three per cent next year.

“Weakening inflationary pressure should put the Bank of England in a position to begin cutting interest rates from the middle of the year,” they said.

“We expect interest rates to fall by 100 basis points this year and end this cycle at three per cent by the second half of next year”.

The Bank of England left interest rates on hold for the fifth consecutive meeting last week. Andrew Bailey, governor of the Bank, said inflation was “moving in the right direction” suggesting rate cuts are on the cards.

Markets expect the first rate cut to come in June.