There is no consensus over just how many times the Bank of England will cut interest rates in 2025.
Having been wrongfooted by a cautious BoE, which only cut rates in August and November last year, financial markets are now pricing in just one in 2025, in February. This time last year, swaps markets indicated six potential cuts in 2024. And just a few weeks ago, the expectation was for three cuts in 2025.
But some believe market pricing is wrong.
Mark Preskett, senior investment consultant and portfolio manager at Morningstar Investment Management, won’t put a number on the rate reductions he expects in 2025. But he is convinced there will be cuts.
“The interest rate swap market has been not the best predictor of rate cuts,” he says.
“It’s fair to say that inflation seems to be on the way down in the UK. That could pave the way for three or four rate cuts next year.”
What Stagflation Could Mean for Interest Rates
Underlying this is a debate around the UK’s economic prospects.
On the one hand, concerns abound that the UK is facing stagflation, in which prices continue to rise and economic activity continues to fall.
This is a bind for the Bank of England. A cooling economy would normally indicate that rates need to fall to stimulate economic activity. And yet sticky inflation could mean it holds rates where they are.
Latest Consumer Price Index (CPI) data for November shows inflation running at 2.6%. Interest rates are currently at 4.75% following a December hold. Latest gross domestic product figures for Q3 2024 show zero economic growth.
Simultaneously, the Bank of England is yet to fully quantify the effects of the government’s planned increase in employer National Insurance contributions in April, though Governor Andrew Bailey said it is his biggest domestic economic concern. Measures introduced in the October Budget are widely expected to be inflationary.
If employers pass on the costs of that bill to consumers, prices will surely rise in some consumer-facing sectors. That could mean the Bank remains cautious. But there are other reasons to cut.
The Global Shift Toward Rate Cuts
“We are now seeing rising unemployment. Jobs market tightness is on the way out. All the signs are that we should see wage inflationary pressures ease over the coming quarters,” Preskett says.
“With history as a guide, we have got interest rates well above the rate of inflation, so that tends to slow economies down. It’s happening in the US. It’s happening across the world. Whether we get four next year is open to debate, but we will definitely see central banks easing.”
Where Will Interest Rates End Up?
While rate cuts are likely this year, just how low the BoE will go has divided commentators in a discussion over the “terminal rate”, the lowest point in this current cycle. Bailey’s own indication that he is expecting as many as four rate cuts has also caused a stir.
Andrew Raikes, fund manager of the TT UK Equity Fund, which has a Morningstar Rating of Gold, isn’t convinced.
“We could end up with three rate cuts rather than four,” he says.
He adds that the UK is currently expected to bottom out at around 3.5%, similar to the US, but higher than Europe.
Others remain confident of four.
“I am reticent to say this because the market has been so wrong. But I think we’ll see four rate cuts,” says Jacob Reynolds, portfolio manager of Courtiers UK Equity Income which has a Morningstar Medalist Rating of Bronze.
“That’s what’s going to take us down to 3.75%, which is what Andrew Bailey is saying, isn’t it? That feels about right. I don’t think rates will go much lower than that.
“Inflation will hover around 2%. Again: long-term inflation has been about 2.7% since 1989. We are about average now.”
Market Experts are Divided on Rate Cuts
Fund manager opinions aside, financial institutions are also divided.
The BlackRock Investment Institute outlook for 2025 predicts the BoE will cut rates “more than the market is expecting.” J.P. Morgan Asset Management’s own outlook suggests the Bank may “cautiously ease its foot off the brake further.” Goldman Sachs says there are “compelling reasons” to expect “continued quarterly cuts in 2025.”
Morgan Stanley is more bullish. It predicts five rate cuts in February, March, May, August, and November, resulting in a base rate of around 3.5%. Bank of America also sees the “terminal rate” of 3.5% by early 2026, which implies five rate cuts from the current level.
How Can Investors Navigate Falling Interest Rates?
In theory, falling rates will aid anyone with credit card and mortgage debt, and make cash held on deposit by savers less attractive.
But the reality is more complex.
Banks largely haven’t been passing on higher interest rates to savers, and a significant portion of UK mortgages are on fixed-rate products. As their lower rates come to an end in the coming months, they will find themselves paying more interest even if rates are falling.
But there are also investment opportunities. Housing stocks are still an obvious pick, Preskett says. There is a debate over whether banks, which have enjoyed share price boons over the last 12 months are still attractive.
“We have already seen it in price action in Q4 2024, whereby lower rates were a positive for housebuilders and for mortgage borrowers. We have also started to see the housing market picking up as prices rise again. Residential property companies should do well.”
Utilities are also sensitive to interest rates because these stocks tend to have higher debts than those in other industries.
“They are very simple businesses to value and the rate matters more for that sector than probably any other,” says Preskett.
“They sold off materially when rates were rising in 2022, and they’ve recently started to get back those losses.”
Which Stocks Will Respond to Rate Cuts?
Small-cap stocks are attractively valued on a price-to-earnings basis, he adds, and will benefit from lower rates.
“On average they have more debt on their balance sheets than large caps, so falling rates will ease the burden for these firms,” he says.
“That said, there is a caveat there with small caps, which is the state of the economy. A recession is a much trickier place for small caps.”
And as for banking stocks, views differ. In 2024 UK banks were among the best-performing stocks on the London Stock Exchange—helped by higher rates and not passing on the benefits to savings account holders.
“Very simply: they have been able to lend at the current market rate, but their net interest margins have expanded because they haven’t been passing those rates on via savings accounts,” Preskett says.
“We are now neutral financials in our portfolios because of the anticipation around the rate cycle. Their prices have risen and thus they are not cheap anymore.”
The Case for Banking Stocks
Others disagree, however.
“The common perception is that banks benefited from interest rates going up and would therefore suffer if interest rates go down,” Raikes says.
“I don’t think that’s the case. If you speak to the UK’s banks, they would say that, if interest rates plateau at 3.5%, that’s actually a pretty sweet spot for them in terms of profitability, because that’s not going to impact their net interest margins.
“They effectively put in hedging programmes to smooth their earnings as interest rates fall. So people might worry about falling rates being bad for banks. I think they are in in a sweet spot. If anything, we’ve added to our exposure recently.”
With additional reporting by Christopher Johnson and James Gard
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar's editorial policies.
