The Bank of England is facing a dilemma over how quickly and dramatically to cut interest rates in 2025 because of the “uncertainty” created by the Government’s decision to hike national insurance (NI) for employers, experts have warned.
The Bank tends to cut interest rates when it becomes confident that inflation is returning sustainably to its 2 per cent target, but has admitted that the impact of the Budget – along with trade policy uncertainty and geopolitical tensions – remains unclear.
This includes the impact of Donald Trump’s presidential victory, including higher tariffs, and the ongoing Russia-Ukraine war, which could have an impact on global inflation.
Experts have said that at the moment, this leaves it hard to say when interest rates will first be cut, leaving the 1.8 million mortgage holders set to come off fixed rates in 2025 in limbo.
Many economists have said a reduction in the base rate in February is still possible, lowering rates to 4.5 per cent, but that it is “far from a slam dunk”.
The Bank of England held interest rates at 4.75 per cent at its latest meeting on Thursday, but against expectations, three of the nine-strong Monetary Policy Committee (MPC) voted to reduce rates.
In its notes, published alongside the decision, the MPC said: “The combined effects of the measures announced in the Budget were provisionally expected to boost the level of GDP by around 0.75 per cent, and CPI inflation by just under 0.5 per cent of a percentage point, at their peaks relative to the August projections.”
Labour confirmed at the Budget it will increase NI payments by 1.2 percentage points for employers, from 13.8 per cent to 15 per cent. There will also be a significant reduction in the secondary earnings threshold at which employers start making NI contributions. This will fall from its current level of £9,100 to £5,000.
Economists have said some of the extra cost will be passed through via lower wages and some via higher prices.
The Bank said in its notes: “There remained significant uncertainty around how the economy might respond to higher overall costs of employment, including from the increase in employer national insurance contributions and the National Living Wage.”
It also said it was downgrading its forecast for economic growth in the last quarter of 2024 from 0.3 per cent to 0 per cent, adding to a risk of ‘stagflation’ – where an economy faces low growth and high inflation combined.
And it said incoming data “would help to clarify the potential trade-off between more persistent inflationary pressures and greater weakness in output and employment”.
Thomas Pugh, an economist at RSM UK, said: “The key uncertainty remains how firms will respond to the rise in NI from the autumn Budget. If firms pass costs on by more than expected then inflation will rise further, but if firms offset the costs through lower pay growth, then that might give the Bank room for further cuts.
“More broadly, the MPC is once again dealing with the dreaded trade-off between weak growth and rising inflation.”
Edward Jones, a professor of economics at Bangor University said: “That NI increase is creating uncertainty, which is what the Bank doesn’t like – they don’t know what to do to respond.
“If you have something that you know will be bad, you can respond, if you don’t know what the outcome will be, it’s more challenging.”
Robert Wood, chief UK economist at Pantheon Macroeconomics, said the MPC was “at pains” to say it wanted more data.
He added: “November GDP and the next labour market release, published in January, along with the Bank of England’s pay settlements survey published in the February Monetary Policy Report could offer enough information, so a February rate cut still looks more likely than not to us. But it is far from a slam dunk.”
Fewer interest rate cuts next year could leave those renewing their mortgages facing higher-than-expected costs, pushing down their disposable household income.
Many of those on fixed mortgages will still be moving onto deals higher than their existing ones, especially if they fixed a couple of years ago when rates were as low as one per cent.
However, they will be hoping rates fall below 4 per cent next year, as has been predicted by brokers.
The current average two-year fix is 5.46 per cent while the average five-year is 5.23 per cent.
People on variable mortgages will also be hoping for a cut as their deals follow the base rate. The sooner interest rates fall, the sooner their monthly repayments will too.
These people tend to be paying more, with the average standard variable rate as of 1 December coming in at 7.85 per cent.
Low growth would also be bad news for Rachel Reeves. The Government needs sustained growth to meet its spending commitments without having to avoid having to raise taxes again.
The Government also said one of its key missions was achieving the highest “sustained” growth among the G7 group of countries, made up of Canada, France, Germany, Italy, Japan, United Kingdom and United States.
