The Bank of England has warned that rising food prices could drive inflation to 4% as it voted for a fifth cut in interest rates in a year, amid mounting concerns about the strength of the UK economy.
In one of its closest decisions since its independence more than 25 years ago, the Bank’s monetary policy committee (MPC) voted by 5-4 to cut its key base rate by a quarter- point to 4%.
The cut, taking borrowing costs to the lowest level since March 2023, was widely expected in financial markets. However, the decision was a close call, with the rate-setting panel for the first time in history holding two votes before reaching its verdict.
Andrew Bailey, the Bank’s governor, said: “We’ve cut interest rates today, but it was a finely balanced decision. Interest rates are still on a downward path, but any future rate cuts will need to be made gradually and carefully.”
City investors reacted to the decision by sending the pound higher on foreign exchanges, after Bailey warned that mounting inflation risks could delay further rate cuts. “I do think the path continues to be down … [But] the path has become more uncertain because of what we’re seeing,” he said.
The chancellor, Rachel Reeves, welcomed the cut, which will ease some of the financial pressure on borrowers. Pressure is also mounting on the government over its management of the economy, and speculation is swirling about tax rises in her autumn budget.
Ministers have sought to claim credit for the Bank’s rate cuts since its first reduction last August, with borrowing costs now down from a peak of 5.25%.
“The stability we have brought to the public finances through our plan for change has helped make this [rate cut] possible,” Reeves said on Thursday.
However, critics say the chancellor’s tax-raising autumn budget has added to the pressure on businesses and households amid global uncertainty from Donald Trump’s trade war.
In a blow to the government, Threadneedle Street said tax rises were contributing to rising inflation and unemployment as it sounded the alarm over the country’s weak growth prospects.
Publishing updated forecasts, the MPC singled out fast-rising food prices as it warned that food price inflation was on track to reach 5.5% before the end of the year. It attributed much of the rise to global factors, including increasingly extreme weather events hitting cocoa and coffee harvests, highlighting the dangers from the climate emergency.
However, it also pointed to “material” rises in employment costs and new charges for recycling packaging, both driven by the government, that were being passed on to shoppers by UK supermarkets.
“In addition to global agricultural commodity prices, domestic labour costs are currently an important driver of food price inflation,” the Bank said.
Business leaders had warned that Reeves’s £25bn increase in employer national insurance contributions (NICs) and a 6.7% rise in the “national living wage” from April would force them to cut jobs and put up prices.
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Official figures show unemployment has crept higher in recent months, while the economy shrank in April and May. Inflation has also risen by more than expected, reaching 3.6% in June.
Facing double-sided risk to the UK economy from weak growth yet mounting inflationary pressures, the split MPC decision in favour of cutting rates was swung by the external economist Alan Taylor.
The independent MPC member, who has repeatedly backed deeper cuts in borrowing costs, had first voted for a half-point reduction before joining the narrow majority – including Bailey – supporting a quarter-point cut.
Exposing tensions at the heart of Threadneedle Street, the four other members – including the Bank’s chief economist, Huw Pill, and one of its deputy governors, Clare Lombardelli – voted to keep rates unchanged.
Inflation has fallen back substantially in the past two and a half years from a peak of more than 11% in late 2022 after Russia’s invasion of Ukraine. That progress has allowed the Bank to cut rates. However, it said lingering inflationary pressures could delay future rate cuts.
“The MPC judges that the upside risks around medium-term inflationary pressures have moved slightly higher since May,” it said.