The Bank of England has chosen to hold its base interest rate steady at 3.75%, a decision that had been widely anticipated by economists and financial markets. The move comes as inflation remains above the Bank’s 2% target, making it difficult for policymakers to justify an immediate reduction. However, many analysts believe that this pause could be followed by gradual cuts later in the year if economic conditions continue to improve.
Inflation rose to 3.4% in December, reversing some of the progress made in previous months. This increase has made short-term rate cuts unlikely, as the Monetary Policy Committee (MPC) remains cautious about loosening policy too soon. Officials are determined to avoid repeating mistakes made after the pandemic, when inflation surged more rapidly than expected.
Despite this, looking further ahead, there is growing optimism that interest rates could begin to fall before the end of the year. A number of major financial institutions are forecasting two quarter-point reductions if inflation shows a sustained downward trend and wage growth continues to slow.
Julien Lafargue, chief market strategist at Barclays Private Bank and Wealth Management, said that the overall economic picture is beginning to support the case for lower rates. He explained that declining inflation and signs of weakening in the UK labour market should encourage the Bank to consider easing monetary policy. Lafargue suggested that the first cut could even arrive as early as next month if data continues to move in the right direction.
Economists at ING share a similar view and are predicting a sharp fall in inflation during the spring. They expect headline inflation to drop from 3.4% in December to around 1.8% by April, taking it below the Bank of England’s target of 2%. Such a drop would significantly strengthen the argument for cutting interest rates in the first half of the year.
ING believes several factors will help drive this reduction in inflation. Food price increases are expected to slow further, while household energy bills should fall when Ofgem resets the price cap in April. In addition, water bills are set to rise by less than previously feared, and rental growth is beginning to cool after a prolonged period of sharp increases. Together, these developments could ease pressure on household budgets and improve consumer confidence.
James Smith, ING’s economist for developed markets, expects interest rate cuts to take place in March and again in June. This timetable would represent a faster pace of easing than financial markets are currently pricing in. Smith explained that much of the expected decline in inflation is already effectively guaranteed due to regulated price changes and adjustments in taxation.
He added that inflation is likely to remain close to the 2% target through the spring and summer months. According to his analysis, around 0.8 percentage points of the fall from December’s inflation reading is already built in, making a significant drop highly likely unless unexpected shocks occur.
However, not all economists agree that the Bank of England will move quickly. Some warn that policymakers are likely to proceed cautiously, especially given the uncertain global environment. Victor Trokoudes, founder and chief executive of the savings app Plum, pointed out that central banks across the world are now following very different policy paths.
In the United States, there is increasing pressure on the Federal Reserve to begin cutting rates. In contrast, the eurozone is taking a more patient approach, while Australia has kept policy tighter for longer. This divergence, Trokoudes argues, makes the Bank of England’s task more complex and increases the likelihood of a careful, measured response.
Trokoudes also highlighted early signs of improvement in the UK economy. Gross domestic product grew by 0.3% in November, and business confidence improved in January. The S&P PMI index reached 53.9, its highest level since April 2024, suggesting that activity in the private sector is picking up.
Despite these positive signals, Trokoudes believes the Bank will avoid rushing into rate cuts. He said comments from Governor Andrew Bailey suggest that interest rates are now close to a “neutral” level — one that neither stimulates nor restricts economic growth. This implies that only limited reductions may be delivered this year.
Inflation remains a key concern for policymakers. As long as price growth stays above 3%, many members of the MPC will worry that underlying pressures could become entrenched. The Bank remains particularly sensitive after underestimating the strength of inflation following the pandemic and is determined not to repeat that error.
The labour market is another area closely watched by economists. Although private sector wage growth has slowed from around 6% earlier in the year to approximately 3.6%, there are signs of increasing strain. The redundancy rate has risen from 3.8 to 4.9 per thousand employees, raising fears of a sharper slowdown in employment.
While slower wage growth helps reduce inflationary pressure, rising redundancies could weaken consumer spending and overall economic momentum. This creates a difficult balancing act for the Bank of England as it weighs the risks of acting too soon against the dangers of waiting too long.
Other experts have also urged caution. Melanie Baker, senior economist at Royal London Asset Management, said that interest rates may remain unchanged for longer than markets expect. She stressed that future decisions will depend heavily on incoming data and that there are both upside and downside risks to inflation and the labour market.
Edward Allenby, senior economic adviser at Oxford Economics, described the current situation as a “delicate balancing act” between supporting economic growth and preventing inflation from becoming embedded in the economy. He believes that wage settlements will be crucial in shaping future decisions and expects the next rate cut to come in April.
Matt Swannell, chief economic adviser to the EY Item Club, also pointed to April as the most likely timing for a reduction. By then, he said, the MPC should have clearer information about pay awards for 2026 and whether further slack is emerging in the labour market.
The Bank of England previously reduced interest rates from 4% to 3.75% in December, marking the lowest level seen in three years. At that time, officials signalled that rates were likely to follow a gradual downward path, although the vote was narrowly split and accompanied by a cautious outlook.
The Bank rate is the main tool used by the MPC to control inflation and guide it back towards its 2% target. It has a powerful influence on borrowing costs, mortgage rates and savings returns across the UK economy.
Around one third of UK households have a mortgage, including roughly one million borrowers on tracker or variable-rate deals that move directly in line with the Bank rate. For these households, any future cuts would bring immediate relief in the form of lower monthly repayments.
Most mortgage holders, however, are on fixed-rate deals, meaning their payments do not change straight away when rates move. Even so, borrowing costs for new buyers and those refinancing have already begun to fall. Fixed mortgage rates declined at the start of the year as lenders competed more aggressively for customers.
This has provided a modest boost to the housing market, where activity had slowed sharply during the period of high interest rates. If rates continue to fall, demand could strengthen further, supporting house prices and improving confidence among buyers and sellers.
Looking ahead, much will depend on how quickly inflation falls and whether the labour market continues to soften. If price pressures ease as expected and wage growth slows further, the Bank of England may feel increasingly comfortable beginning a series of small, carefully measured rate cuts.
While policymakers remain cautious, the outlook suggests that 2026 could mark the start of a gradual shift towards lower borrowing costs after several years of tight monetary policy. For households and businesses alike, this would represent a welcome change following a prolonged period of high inflation and rising living costs.
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