What the UK interest rate cut means for savings, mortgages, the economy and inflation

In its first decision of 2025 the Bank of England has cut interest rates from 4.75% to 4.5% – marking a 20-month low and the third rate cut in just over six months.

While a rate cut was firmly on the cards, it’s interesting how the vote was split, with two members of the MPC preferring a chunkier cut to 4.25% to send a bigger signal to markets about the health of the UK economy.

Interest rates are now back to where they were in May 2023, when rates were still on their climb upwards, and inflation was clocking in at 8.7%. The environment feels different now, with that CPI inflation figure having dropped down to 2.5% and much of the cost-of-living price hikes behind us.

However, the path for interest rates is still murky. Opinion is divided on by how much and how fast interest rates will be cut this year, with markets pricing in two or three cuts, while some economists think it will be four of five.

April is the crunch month for inflation, with higher National Insurance and minimum wage costs for employers, energy price rises for consumers, and Trump’s trade war all being potentially inflationary. There are many unknown variables looming – the biggest of which is what impact political changes will have on inflation and the path for rates.

Donald Trump’s trade war could prove inflationary, if the cost of new tariffs gets passed on to consumers. On top of that, higher wage costs land in April, with many businesses saying that cost will have to be passed on to consumers. And we’re expecting higher energy prices to land in April too, as Ofgem’s energy price cap rises again. All of that could prove inflationary – and higher inflation likely means a delay to future interest rate cuts.

Source: Bank of England

What does it mean for savings?

Savers are in a better position now than last time interest rates were at 4.5%. Back in May 2023 the top easy-access current account was paying 3.7% but now savers can get 4.7% from an easy-access account with no withdrawal restrictions. They can get even more if they are willing to limit their withdrawals from the account each year.

But average rates have fallen in the past year and lots of people will be earning piddly amounts on their savings. Even if you took action to switch accounts during the period of high savings rates, if it’s been more than a year since you moved accounts, you might find the rate you’re getting has plummeted and you need to ditch and switch again.

While interest rates on savings have been generally falling, the competitive period of tax-year-end has helped to prop rates up. What’s more, anyone looking down the barrel of paying tax on their savings will be pleased that there is more competition in the cash ISA market – with the highest easy-access rates being cash ISA accounts.

We know that almost 2.1 million people are expected to pay tax on their savings this year, up from around 650,000 just three years ago*. This tax-year-end is a good chance to assess whether you’re likely to get an unexpected tax bill and shovel some money into a cash ISA if so.

What does it mean for mortgages?

Many homeowners will be baffled that despite multiple interest rate cuts, average mortgage rates are higher than they were a year ago. Even ahead of the latest base rate cut, which looked like a dead cert, mortgage rates headed in the opposite direction.

Two-year fixed rates are now higher than they were in November last year and only a smidge lower than February last year** – despite two base rate cuts since then, while five-year rates are higher than two years ago.

Homeowners have the turmoil in the bond markets to thank for their higher mortgage bills. While mortgage rates are linked to the base rate, they aren’t directly based on them. Instead, they are reliant on swap rates, which track government bond yields – so bond market turmoil raises yields, increasing borrowing costs for banks and, in turn, mortgage rates.

There is good news for anyone on a tracker or variable rate mortgage, who will see their monthly mortgage costs drop as a result of the latest cut. For someone with £125,000 of mortgage borrowing***, the 0.25 percentage point cut means an £18 a month saving on their bill, while for those with £400,000 of mortgage borrowing a 0.25 percentage point cut means a £58 monthly saving – or almost £700 a year.

*Based on a Freedom of Information request from AJ Bell

**According to Moneyfacts figures

***Based on a 25-year repayment mortgage

What is the outlook for inflation?

The most striking announcement from the Bank of England is not the cut in interest rates, but the prospect of inflation rising to 3.7% this year while its forecasts show the economy continuing to flirt with recession. Rising prices will not make for happy consumers who have might have hoped that high inflation is in the rear-view mirror.

CPI at 3.7% is nowhere near the double-digit inflation we saw at the height of the cost-of-living crisis, but it adds to the cumulative load of price rises.

It also sets up the potential for a round of higher salary negotiations, and with wage growth already running hot, this might stoke further inflationary pressures. The Bank can control these by keeping interest rates higher, which would mean more sustained pain for mortgage borrowers and for companies refinancing debt.

The primary culprit for rising inflation is higher energy prices, but the chancellor’s Budget policies are also expected to push up prices. Namely the hike in National Insurance, VAT on private schools and the rise in the cap on bus fares. The big downgrade in the growth forecast for 2025 will also come as a blow to the chancellor who has made growth her key mission. It’s looking increasingly likely that Rachel Reeves is going to have to do something substantial alongside issuing the Spring Statement in March, despite committing to only one fiscal event per year.

Will we see further rate cuts this year?

The market is still pencilling in two interest rate cuts by the end of this year, but beyond that rates are expected to remain pretty steady at around 4% for the next couple of years.

Predicting rates so far out is about as reliable as reading tea leaves at the best of times. Given the ructions we’ve seen in international markets as a result of President Trump’s new tariff proposals, the crystal ball is clouded by an especially dense fog at the moment.

The Bank hasn’t factored into its forecasts any effects from Trump’s trade tariffs at the moment, seeing as they have only just started to emerge and are highly uncertain in their formulation and implementation. However, we know rising global trade tariffs do pose a further threat to UK economic growth and the inflationary environment.

Overall, the Bank is painting a pretty bleak, stagflationary picture for 2025, which could get worse if Trump pushes through with widespread trade tariffs. It’s not the news anyone wants to hear, but then again, we’re getting used to it.