On November 7, 2024, the Bank of England (BoE) announced a reduction in its base interest rate to 4.75%, down by 0.25 points, marking the second cut in the year. This decision follows a series of choices by the central bank to balance economic growth and inflation. While the reduction reduces the cost of borrowing for those trying to take out loans, the challenges it presents for borrowers and general longevity need to be questioned.
Rationale Behind the Rate Cut
The decision to lower the interest rate comes when the UK’s economy grapples with mixed signals. On the one hand, inflation has shown signs of easing, but growth remains sluggish. The Bank of England's primary objective in cutting rates is to stimulate economic activity. With inflation dropping to 1.7% in September 2024—reaching the BoE's target of +/- 2% for the first time in three years. According to the BoE, while inflation has decreased, the risk remains, especially considering external factors such as global economic uncertainty and ongoing geopolitical tensions such as Trump’s recent victory in the US elections against Harris.
The BoE's Monetary Policy Committee emphasised that the rate cut is designed to help support demand across various sectors, making borrowing cheaper for consumers and businesses. The rationale behind such a move is rooted in core economic theory: a reduction in the cost of borrowing encourages firms to take out loans and expand their production processes. This, in turn, increases employment opportunities as more labour is required to support increased productivity.
Impact on Borrowers
The reduction is a welcome development for homeowners and businesses with loans linked to the BoE's base rate. Mortgage holders, particularly those with variable-rate loans, will see their monthly repayments drop, reducing their financial burdens. This comes as many households are struggling with higher living costs. For businesses, lowering borrowing costs could stimulate investment, fostering growth in industries crucial for the UK's economic recovery and allowing the government to reallocate funds spent on unemployment benefits and training schemes towards healthcare and schools, as Chancellor Rachel Reeves recently pledged.
The lower interest rates also open opportunities for new homebuyers as mortgages become more affordable, potentially boosting the housing market. However, the reduction may not be enough to reduce the recent trend of 1 in every 4.5 families living with a child above 18 years old (as of 2021) due to the soaring house prices and instability in job markets.
Impact on Savers
While borrowers stand to benefit, savers may find the interest rate reduction disappointing. Lower rates will likely decrease the return on savings accounts, bonds, and low-risk investments. In response, many savers may consider diversifying their investments into higher-risk assets such as stocks, real estate, or more speculative bonds, seeking better returns.
However, this increased risk exposure may not be ideal for conservative investors or those approaching retirement who prefer the stability of fixed-income investments. Lower rates might also prompt some individuals to rethink their financial strategies, shifting away from saving towards more aggressive investment practices.
Long-Term Economic Implications
The rate reduction is part of a broader strategy to support the UK's economic growth during uncertainty. With global economic slowdowns and concerns over trade relationships, particularly with the European Union and other major markets, the BoE uses its tools to cushion domestic businesses and consumers.
The BoE has clarified that risks are involved while it expects the rate cut to boost economic activity. Prolonged low interest rates can lead to asset bubbles, particularly in housing markets, as seen in the 2008 financial crisis. Furthermore, with ongoing fiscal pressures and global uncertainties, there are questions about how much impact this monetary policy shift can have.
Conclusion
The recent reduction in interest rates by the Bank of England is a response to a complex set of economic challenges. While it provides immediate relief to borrowers, it also poses challenges for savers and raises concerns about long-term financial stability. The effectiveness of this measure will depend mainly on its ability to stimulate economic growth while managing the risks of inflation and market instability. As the UK continues to navigate these uncertain financial waters, the Bank of England will likely face additional decisions on balancing growth and inflation control in the coming months.