Interest rate cut a watershed moment – but the Bank is still paranoid about inflation

It has been a long time coming.

After two years during which the Bank of England raised interest rates at nearly every meeting – and another year in which those rates sat at what is, for many households and businesses, a painfully high level – today they have finally been cut.

So this is a watershed moment – a critical turning point for the UK economy.

Money latest: Reaction as the Bank of England cuts borrowing costs

Interest rates are the Bank’s main tool for trying to control inflation. Higher rates deter people from borrowing and encourage them to save – hence less money gets spent out there in the economy and retailers become less confident about setting high prices.

High interest rates are, to put it more bluntly, a form of economic pain. And the Bank thinks that even at 5%, where they are now after today’s cut, they are still at a painful level – or, as they would put it, “in restrictive territory”.

This is a large part of the explanation for why unemployment is higher, house prices are lower and for why many households are still struggling – even though the annual rate of inflation is now back to the Bank’s target rate of 2%.

So the decision to cut rates will start, gradually, to reduce that pressure – that pain. Indeed, in some senses the pain is already reducing somewhat: mortgage providers, anticipating lower Bank of England rates, have already begun to reduce fixed rate mortgage rates. Today, those with floating rate mortgages will see an instant reduction in their costs.

The big question now is: what next? First things first, don’t expect those borrowing costs to come down as quickly as they went up. Markets think there might be one more cut this year, and that borrowing costs will come down quite gradually.

Second, few people inside the Bank expect borrowing costs to come down to the levels they were at back in 2021, when they were sitting at a historic low of 0.1%. Instead, they seem moderately happy with market expectations that rates will drop only to 3.5% over the next three years.

Are interest rates still in “restrictive territory” then? That’s a question no one at the Bank wants to answer.

The Bank’s decision today wasn’t exactly a surprise: financial markets had put the probability of a rate cut today at over 60%. Even so, it was perhaps the most finely-balanced decision in a long time.

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Far from being a unanimous verdict, four of the nine members of the Monetary Policy Committee actually voted to leave interest rates at 5.25%. This wasn’t, in other words, a slam dunk.

And the documents released alongside the decision were chock-full of provisos: rates would need to “remain restrictive for sufficiently long until the risks to inflation retuning sustainably to the 2% target in the medium term had dissipated further”.

In other words: we’re not out of the woods yet.

The Bank is still paranoid about inflation. Then again, it always was. And today it finally cut interest rates – and signalled there will be more to come in the coming months.