The Bank of England has just lowered interest rates for the first time since July 2023.
The Bank’s central rate has dropped from 5.25% to 5%, a move which will be much welcomed by borrowers.
Interest rates set by the Bank influence those set by lenders across the country, and generally define the cost of borrowing money – so this decision is a big deal.
Why has the interest rate just changed?
This is also the first time the Bank has lowered the interest rates since the start of the Covid pandemic.
There was no guarantee the rate was going to fall this month and many economists said it was “too tough to call” what the Bank would decide ahead of time.
Today’s announcement comes after inflation – the rate at which prices change over a 12-month period – stayed steady at its target rate of 2% for two consecutive months.
It is the Bank of England’s responsibility to keep inflation at this target rate, set by the government, because it is seen as the ideal rate to make sure the economy grows but without pricing people out of the cost of living.
The interest rate is the main lever the Bank uses to control inflation.
But Threadneedle Street had previously indicated it was watching several other factors, too.
It wanted to see if price growth in the service sector of the economy is slowing down, and if the job market is cooling.
Wage growth slowed to the lowest level in two years in May, and unemployment rates remained unchanged although the number of job vacancies fell by 30,000.
How did we get here?
Inflation soared to a 41-year high in October 2022, reaching a whopping 11.1%, which is why the Bank of England started to increase its interest rate.
Since the 2008 financial crisis, the rate had been kept below 1% – in fact, in December 2021, it was at 0.1%, a record low.
But the cost of living crisis, triggered by soaring energy prices and the pandemic, meant inflation started to soar.
The Bank started to increase interest rates incrementally in an effort to keep inflation in check.
But inflation turned out to be exceptionally stubborn, so the Bank kept increasing interest rates until it reached 5.25% – a particularly high rate last used in April 2008 – which started to decrease economic activity.
Spending declined so much that the UK even went into a brief and shallow recession at the end of last year, but it came out in the first quarter of 2024.
How will this interest rate fall impact you?
Lower rates increase the value of wealth, like pensions or housing.
If rates decline and you have a loan or mortgage, your interest payments may reduce – but you may also earn less interest on your savings.
Lower rates generally means more spending, which helps the economy in general.