Projected UK interest rates in 5 years
Bank of England (BoE) cut rates for the first time in August 2024, with further easing expected in the coming months. But how low are rates likely to go?
The UK interest rates rose sharply in 2022 and 2023 to combat soaring inflation. Since then, cooling growth and less persistent inflationary pressures have seen the Bank of England (BoE) cut rates for the first time in August 2024, with further easing expected in the coming months. But how low are rates likely to go?
Here we take a look at the projected UK interest rates in 5 years, and what factors may shape them in the long-term including inflation, economic growth and the labour market.
What is the Bank of England (BoE)?
The Bank of England (BoE) is the central bank of the United Kingdom. Founded in 1694, it is the second-oldest central bank in the world after Sweden’s Sveriges Riksbank.
The BoE was founded as a private bank to the government and established by a royal charter granted by King William and Queen Mary in 1694.
The bank’s main purpose at the time was to raise £1.2m in loans for the government to finance the war against France. More than 1,200 people bought the ‘bank stock’ (shares) issued by BoE, making them the first shareholders.
They came from a variety of backgrounds, trades and professions, including carpenters and grocers, merchants, doctors, knights and royalty. King William and Queen Mary, too, were among the original stockholders.
As a central bank, the BoE’s primary mandate is to keep prices stable by making sure that inflation stays at 2%. To do so, the BoE changes its key interest rate, known as the bank rate, to control inflation.
The job of adjusting the bank rate is in the hands of the Monetary Policy Committee (MPC), which consists of nine members – the governor; the three deputy governors for monetary policy; financial stability and markets; and banking.
There is also a chief economist, and four external members, who are appointed directly by the Chancellor of the Exchequer – the second most important member of the cabinet after the Prime Minister.
Members of the MPC are appointed for a set period and may be replaced or reappointed. The committee makes decisions on what monetary policy action to take eight times a year, or once every six weeks.
Other BoE functions include producing bank notes, supervising payment services, and regulating and supervising major banks and other financial institutions, such as credit unions and insurers.
The BoE also manages the UK’s gold reserves and gold held by other banks. BoE vaults contain approximately 400,000 gold bars.
Projected interest rates in 5 years in the UK
Projected interest rates in the UK over the next five years show a trend towards gradual declines after reaching higher levels in response to inflation. As of late 2024, the Bank of England (BoE) is expected to deliver one or two more rate cuts, which could bring the average rate down to around 4.75% - 4.50% by the end of the year. The outlook for 2025 suggests continued easing, with rates potentially falling further to between 3.75% and 3.5%. The Bank of England forecast from the November meeting shows rates dropping to 3.7% in 2025.
By 2026, some forecasts predict interest rates might stabilise around 3.5%, assuming the BoE successfully manages to keep inflation closer to its 2% target. This trajectory reflects a move away from the exceptionally low rates experienced in the post-2008 financial crisis and pandemic periods, as the economy adjusts to a more stable and sustainable growth environment.
UK interest rate history
The Bank of England interest rate history shows that the bank started to aggressively cut its key interest rate in February 2008. The effect of the global financial crisis, which started in the US with the housing market bubble in 2007, had begun to hit the UK economy. Over the course of 2008, BoE made five rate cuts, which dropped the rate from 5.25% in February to 2% in December, a level last seen during banking crises in the 1880s and 1890s, according to the International Monetary Fund (IMF). It was also the lowest level in the BoE’s interest rate history since the Great Depression and World War II.
In March 2020, BoE implemented two interest cuts – on 11 and 19 March – which brought the UK interest rates to an all-time low of 0.1%. The BoE’s steep rate cut followed in the footsteps of other central banks and governments that rolled out emergency measures to help their economies weather the pandemic.
First bank rate increase post-pandemic
The near-zero rate was kept until December 2021 as the UK and other countries gradually reopened their economies.
As inflation rose in line with recovery, the BoE increased its bank rate to 0.25% on 16 December 2021 from the low of 0.1%. The UK became the world’s first leading economy to increase its interest rate after the pandemic.
Rebounding demand as the economy gradually recovered from the pandemic, combined with soaring commodity and energy prices resulting from Russia’s invasion of Ukraine at the end of February 2022, has accelerated the pace of price increases.
In 2022, the BoE hiked rates eight times, bringing it to 3.5% by the end of year. In 2023, the UK central bank hiked rates once again by 50 basis points (bps) to 4% in February, by 0.25% to 4.25% at the March meeting, and by another 25 bps in May, leading the rate to 4.5%.
UK inflation peaked in 2022
UK inflation peaked in 2022 driven primarily by skyrocketing energy prices and other pandemic-related supply chain issues. The Consumer Price Index (CPI) inflation reached its highest point in October 2022 at 11.1%, reflecting sharp increases in energy costs due to the Russia-Ukraine conflict, which intensified inflationary pressures globally. This period marked the highest inflation rate in over 40 years. Since then, UK inflation has gradually eased, although it remained elevated into 2023, largely due to ongoing high food and energy prices. By mid-2023, CPI inflation began to moderate more noticeably, and by September 2024, the CPI inflation rate had significantly reduced to around 1.7%, the first time dropping below the BOE’s 2% target since mid 2021.
Labour market shows signs of cooling
As of October 2024, the UK unemployment rate decreased to 4.0%, aligning with market expectations and indicating a slight improvement from previous months. This decline reflects an overall positive labour market trend, where both short-term and long-term unemployment levels dropped, though the latter remains above 2023 levels, highlighting some ongoing challenges. Employment grew notably, with about 373,000 additional jobs added between July and September, bringing the total employment level to 33.37 million.
This trend suggests stability in the labour market, though the slowing job vacancy rate—marking 27 consecutive declines—indicates a cautious hiring environment. Economic inactivity has also decreased to 21.8%, as more individuals are joining the workforce, contributing to resilience in the labour market overall.
Wage growth has also shown signs of cooling in the UK. For the period from June to August 2024, average weekly earnings growth was recorded at 4.9%, down from 5.1% in the previous period. This slowdown is particularly relevant for policymakers as it suggests easing inflationary pressures in key sectors of the economy.
UK economic growth shows signs of stagnation
As of October 2024, the UK's economic growth is showing signs of resilience. In August 2024, the UK's GDP grew by 0.2%, following no growth in July, and in the three months leading up to August, it also increased by 0.2% compared to the previous three-month period.
The growth has been supported by a recovery in various sectors, notably services, which saw a modest rise of 0.1% in August. The retail trade sector was a significant contributor to this growth, as it experienced a 1.0% increase. Furthermore, forecasts for GDP growth have been revised upward; economists are now predicting a growth rate of approximately 0.9% for 2024, up from earlier estimates.
While the UK economy is recovering, it still faces challenges, including high inflation rates, particularly in service sectors, which may influence future monetary policy decisions by the Bank of England.