When will interest rates start to fall? Base rate forecasts

The Bank of England will cut the base rate to around 3 per cent by late 2025, according to the latest forecasts.

That would be a substantial decline from the current 5.25 per cent, but would still represent rates rising like a rocket and falling like a feather. 

Since December 2021, when it stood at 0.1 per cent, the Bank of England has upped the base rate on 14 consecutive occasions.

The market expectation around where base rate will peak appears to be constantly changing with every new slice of economic data that filters through. 

Inflation, wage growth and unemployment are all factors that could impact what happens to the base rate in the future.

At present, markets appear to think that base rate has now peaked at 5.25 per cent.

What the future holds for interest rates will greatly depend on how quickly inflation falls.

Inflation (as measured by the Consumer Price Index) remained at 6.7 per cent in the 12 months to September. That means prices are still up on last year.

However, the situation is better than the double-digit inflation we were witnessing earlier this year.

The conflict in the Middle East continues to dominate the news and, from an economic point of view, casts a shadow over the outlook for inflation due to the upside risk to oil and wholesale gas prices.

But according to Paul Dales, chief UK economist at Capital Economics, there are three reasons for cautious optimism.

‘First, the pre-announced fall in the Ofgem utility price cap in October and a few other favourable developments suggest to us that CPI inflation will fall to around 4.6 per cent in October,’ says Dales.

‘Second, the rebound in services CPI inflation, which the Bank of England considers a key barometer of the persistence of domestic price pressures, from 6.8 per cent in August to 6.9 per cent in September is unlikely to last long.

‘Third, the easing in the growth rate of average earnings from 8.5 per cent in July to 8.1 per cent in August suggests that wage growth, which is the Bank’s other key indicator of domestic price pressures and tends to drive services CPI inflation, is now past its peak.’

But Dales concedes that none of this means the UK’s inflation problem is going to disappear quickly.

He adds: ‘The loosening in the labour market so far has only been modest and inflation expectations remain unusually high. 

‘This suggests that the downward trends in core inflation and wage growth will be slow rather than sudden.

‘So although we doubt the Bank of England will raise interest rates further, we continue to think it won’t be in a position to cut interest rates until late in 2024.’

> What the base rate rise means for your savings and mortgage 

Watch what the Fed does

UK base rate moves have tended to mirror the Federal Reserve in the US.

It makes sense to be moving in a similar direction to other central banks, such as the Fed and the European Central Bank (ECB) to keep the pound competitive.

How the US economy and inflation develops over the coming year and what the Fed does in response will therefore play a major role in what happens over here.

As of September, inflation in the US is at 3.7 per cent – still above its 2 per cent target, but much healthier than the 9.1 per cent peak in July last year.

The US Central bank held rates at the 5.25-5.5 per cent range last month.

What could cause the base rate to be cut?

For almost two years, the Bank of England has attempted to combat rising inflation by continually upping the base rate.

With inflation forecast to fall further over the coming months, this will remove the core reason for the base rate rising in the first place.

Combine that with the risk of higher rates pushing the UK into a recession, and it’s possible to see why the Bank of England could feel obliged to put further rate hikes on hold.

The current assumption by Capital Economics is that now that rates have peaked, they will be held for about a year. 

In predicts interest rates will stay at their peak for a long time, perhaps until late in 2024, before they begin to be cut. They predict the base rate will be cut to around 3 per cent by the end of 2025.

Dales adds: ‘The good news is that some more concrete signs that the inflation problem is fading means that interest rates probably won’t be raised further above the current rate of 5.25 per cent. 

‘But as the inflation problem won’t disappear quickly, households and businesses won’t feel a relief from lower interest rates until late in 2024. Lower interest rates will probably be a story for 2025 rather than 2024.’ 

Dales points out that in the previous 300 policy meetings since the Monetary Policy Committee was formed in 1997, the Bank of England has never provided guidance on how long interest rates will stay high. 

However, he says the average gap between the last hike and first cut is 10 months.

Even so, it is crucial to remember that changing economic conditions always trump predictions.

Dales adds: ‘If the inflation picture significantly eased, then the Bank would suddenly ditch the guidance and start preparing for rate cuts. As such, economists like us can’t switch to autopilot.

‘The two key takeaways are that a peak in interest rates does not mean that a pivot to rate cuts is around the corner and that forward guidance lasts only as long as economic conditions warrant.’

So what does this mean for your interest rates?

Many people assume that savings rates and mortgage rates are directly linked to the Bank of England base rate.

In reality, future market expectations for interest rates and banks’ funding and lending targets and appetite for business are what really matters.

Market interest rate expectations are reflected in swap rates. A swap is essentially an agreement in which two banks agree to exchange a stream of future fixed interest payments for another stream of variable ones, based on a set price.

These swap rates are influenced by long-term market projections for the Bank of England base rate, as well as the wider economy, internal bank targets and competitor pricing.

In aggregate, swap rates create something of a benchmark that can be looked to as a measure of where the market thinks interest rates will go. 

Current swap rates suggest that interest rates will be lower over the coming years, but not dramatically so.

Five-year Sonia swaps are currently at around 4.66 per cent per cent. Before June’s better than expected inflation reading they were above 5 per cent. 

Similarly the two-year swap rate is now 5.04 per cent. Prior to June’s positive inflation reading this was around 6 per cent.

Any borrowers hoping for a return to the rock bottom interest rates of 2021 will likely be disappointed. On the flipside, savers will be reassured rates are expected to plummet to the depths again, but need to also know that unless the outlook changes banks aren’t likely to be raising fixed rates savings deals any higher.

However, it’s worth pointing out that while swap rates are a good metric for where markets think interest rates are going, they also change rapidly in response to economic changes.

For example, in August 2022, five-year Sonia swap rates (used to influence mortgage pricing) were at 3.16 per cent compared to 4.66 per cent today.

Richard Carter of Quilter Cheviot adds: ‘Swap rates are a useful indicator of current expectations, but it is important to remember they are no better at predicting the future than any other economic indicator. The economic outlook can change very quickly and very dramatically.’

What should savers do?

Savings rates remain at levels not seen since 2008/09. 

Savers can get as high as 5.2 per cent in an easy-access account, while they can still get over 6 per cent on fixed rate savings deals at the moment, albeit these may not be around for long, with few 6 per cent plus deals remaining.

Our savings tables show the best easy-access savings and fixed rate savings deals.

James Hyde, a spokesperson at Moneyfacts, said: ‘Inflation remains well above the Government’s target of 2 per cent, and as such is still eating into savers’ money in real terms. It is vital that people consider their options to ensure their investments are delivering competitive returns.

‘Some of the latest top fixed rate deals for savers have fallen slightly since the last inflation announcement, although top rating easy-access accounts have continued to rise. 

‘There is still a good deal of competition and movement at the top end of the market, so savers should have flexibility to spread their cash to allow them to take advantage of higher returns but also retain resilience for any unexpected circumstances. 

‘However, people should be aware that popular accounts may be pulled or their rates could decrease, so swiftness to secure the best option is key.

Hyde adds: ‘Following 14 consecutive base rates, the Bank of England’s decision to pause at 5.25 per cent has precipitated a cooling in the rise of top savings rates, but there continues to be substantial activity between providers, and competitive deals are available. 

‘It remains essential that savers are prepared to vote with their feet if they are not being incentivised to show loyalty. 

‘Savers should consider which type of account suits them best, and how much access they require to their savings, to secure the best return.’

What should mortgage borrowers do?

Mortgage borrowers on fixed term deals should worry less about the base rate changes, and more about where markets are forecasting the base rate to go in the future. 

This is because banks tend to pre-empt the base rate hike. They change their fixed mortgage rates on the back of predictions about how high the base rate will ultimately go, and how long inflation will last for.

Mortgage rates have been on a downward trajectory over the past couple of months, with markets having lowered their expectations of where the Bank of England’s base rate will peak.

All six of the UK’s largest lenders have slashed rates of late, including NatWest, Nationwide, Lloyds Banking Group and HSBC.

The average two-year fix is now 6.35 per cent, according to Moneyfacts, down from a peak of 6.86 per cent and the average five-year fix is 5.9 per cent, down from a peak of 6.37 per cent.

This will only offer marginal relief to mortgage holders. With costs set to be much higher for many of those coming up to a remortgage.

You can check best buy tables and the best mortgage rates for your circumstances with our mortgage finder powered by L&C Mortgages – and figure out what you’ll actually be paying using our new and improved mortgage calculator.

Rachel Springall, finance expert at Moneyfacts, said: ‘Fixed mortgage rates have fallen across the spectrum, signalling a positive change in the market. 

‘Overall, the average two- and five-year fixed rates have now fallen for the second month running, so borrowers could find cheaper deals to choose from. 

‘These are encouraging signs for borrowers who may be looking for a new fixed rate deal, but they still may be on the fence about locking in, hoping rates will fall further in the weeks to come. 

‘Those with a limited deposit will find the average five-year fixed rate at 90 per cent loan-to-value has dropped below 6 per cent for the first time since July and is at its lowest point since June.’

What to do if you need to remortgage 

The big question is what those remortgaging this year should do.

Five year fixed rates tend to be cheaper than two year deals at the moment. But this, of course, means that borrowers will be locked in for longer and be unable to take advantage if rates fall.

Another option for those looking to chop and change as rates come down, is to consider a variable deal such as tracker rate. 

However, they’ll need to choose one without early repayment charges, so they are free to switch without penalty – and this will likely mean they’ll have to settle for a more expensive deal to begin with.

Read our guide on how to remortgage for more information on what to do when a fixed rate or other deal ends. 

David Hollingworth, associate director at mortgage broker L&C says: ‘Longer term fixed rates have remained lower than shorter term options due to the fact that markets expect interest rates to fall back over time, once inflation is tamed.

‘That could see borrowers still considering a variable deal despite the potential for further hikes in the hope that they will be relatively short lived before the Bank cuts rates to support a weaker economy.

‘Alternatively they may opt for a shorter term fixed rate in the hope that rates have eased back once that deal comes to an end.’

What people decide will depend on their own situation and what they envisage playing out over the next few years.

While many may gamble on rates falling over the next two years and opt for two-year fixes, others may prefer to avoid rolling the dice and instead lock in for longer.

Ultimately, whatever people decide to do, they should always plan ahead. It is possible to lock in a mortgage offer six months before it needs to begin. Borrowers can always then change to a cheaper deal nearer the time. 

Chis Sykes, technical director and senior mortgage broker at Private Finance says: ‘We are advising clients against adopting a wait-and-see approach when it comes to locking in these reduced mortgage rates,’ 

‘While there is a prevailing sense of excitement about the prospect of a rate war or a substantial dip in mortgage rates over the next few months, market conditions largely do not align with such predictions. 

‘Individuals can always lock in a mortgage rate today and then re-evaluate the situation if rates fall further down the line.’