UK interest rates: Economic weakness gives the green light to cuts but inflation remains stuck on amber

The Bank of England (BoE) has a delicate balancing act in setting interest rate policy this year as the three way split in the voting committee illustrates. While it just has lowered its bank rate a little further from 4.25% to 4% to help guard against an economic downturn, it does so amid lingering inflationary pressures

Economic weakness gives the green light to interest rate cuts…

Higher unemployment and muted hiring activity are beginning to expose the underlying fragilities of the UK economy. Pay growth is now cooling too, a precursor to less demand-led inflationary pressure, and combined with underwhelming growth numbers it’s no surprise BoE attention is shifting from sticky inflation to the ailing economy.

UK growth moved into reverse gear during the second quarter, contracting by -0.3% in April and -0.1% in May, undoing much of the positive momentum in the first quarter, and business confidence remains at a low ebb. There was some better news in the form of a revision to May’s payrolls figure, which was revised from a decline of 109,000 to a far less steep 25,000, but the fact remains that the jobs market is cooling. Unemployment has already climbed to 4.7% from 4.4% earlier this year, a four-year high.

…yet inflation remains stuck on amber

Ordinarily, this sort of worrying economic trajectory would prompt a robust response from policymakers to cut interest rates and provide much-needed relief to businesses and consumers. However, price rises have reaccelerated over the course of 2025, restricting how far the BoE can go.

CPI inflation jumped to 3.6% in June, the BoE having forecast 3.4%, and further energy and employment market pressures are likely to push the annual rate higher through the year.

Revealingly, annual services inflation stayed at 4.7% in June despite many anticipating it would fall back. This is a key metric to watch as it is driving the overall headline number and is highly sensitive to employment costs which have recently been on the rise thanks to robust wage growth and increases to employer NI and minimum wages. With many businesses passing these onto consumers inflation is likely to easily top 3% for the rest of the year.

Today’s cut seems sensible to help kickstart the economy, but any further cuts are going to be uncomfortable amid a still-inflationary landscape and an uncertain outlook through to 2026.

The impact of tariffs remains an unknown quantity that could cut both ways. The erratic back-and-forth of US trade policy may lead to persistent weakness in global trade and a knock-on impact for the UK economy. At the very least the ambiguity makes it difficult for companies to plan and invest, and at worst could exacerbate economic slowdown at the same time global inflationary pressures seep into the UK.

What is the outlook for interest rates?

Setting interest rates at an appropriate level is rather like balancing the clutch on a car. Set the rate too high and the economy stalls, too low and there’s an inflationary burst forward. Presently, the BoE is most worried about stalling the engine, but the committee appear divided, with some members suggesting rates need to be cut more quickly, while others want to see the remaining puzzle piece of falling inflation before acting more concertedly.

The BoE’s focus has increasingly shifted toward labour market dynamics as a key driver of policy decisions, so these data sets remain very significant going forward to judge the extent to which rates are cut again before the end of the year. With prices evolving broadly as pencilled in by previous BoE forecasts it is fair to expect the roughly quarterly cadence of rate cuts to continue. Yet as the three-way split on the voting committee shows, the competing forces of economic deterioration and sticky price rises obscure a clear view of the path.

What does the BoE rate cut mean for savers?

For savers it may currently be worth considering fixed term accounts where rates are a little more generous than for easy access – provided the money isn’t required before the end of term. If base rates are cut further the return on a fixed rate account will be protected, whereas rates on easy access accounts have little chance of improving and could instead drop away.

By Rob Morgan, Chief Investment Analyst at Charles Stanley