The Bank of England faces perhaps the most difficult policy decision of 2025 on Thursday. With inflation dropping (albeit slowly) and the labour market also showing signs of a slowdown, will the central bank drop interest rates?
The expectation has been that rates will be held at 4%. Some major banks, however, have begun to predict a drop to 3.75%. In either case, the vote is likely to be a close call, much like the 5-4 margin seen in August.
Why UK interest rates could be cut
Up until a few weeks ago, very few people predicted that another 2025 rate cut would happen before the Autumn Budget. In fact, most traders didn’t expect another cut until 2026.
Thanks to the cooling job market and flattening inflation, however, major banks like Barclays and Goldman Sachs now believe a split vote could lead to a November rate cut.
Inflation in September came in at 3.8%, below what analysts had predicted. This has led to bolstered confidence in the Bank of England achieving its 2% inflation target over the coming months. This, coupled with a slowdown in job openings, has raised the possibility of a previously unlikely cut this week.
This time last month, the market-implied probability of an interest rate cut was around 6%. As of this morning (3rd November), the probability of a cut has increased to 30%.
How the decision affects investors
When the Bank of England cuts rates, remember that markets usually move before the announcement. Investors and traders try to guess what’s coming, so the biggest reactions tend to happen when the decision surprises people rather than matches expectations.
For savers, interest rate cuts normally mean lower rates on current and other easy-access accounts, so it’s worth shopping around. If you don’t want to keep switching accounts, you could look at overnight rate Money Market ETFs, which aim to track the Bank of England overnight rate. These can provide a simple way to keep close to the base rate.
Regardless of what happens with rates though, your emergency fund should still sit in cash – its job is to be easy and quick to access, not to generate high returns.
In equities, the link with interest rates is nuanced. By contrast, for bonds the pattern is clearer: actual or expected Bank of England cuts usually lift prices and lower yields, with the largest moves often in longer-dated UK government bonds (gilts). That tends to support existing bond holdings, although new bonds issued afterwards typically offer lower interest.
Looking at currencies, if UK rates fall relative to other countries, the pound may weaken. This is because lower UK interest rates reduce the return on sterling cash and bonds versus foreign alternatives, encouraging investors to move money abroad and, in turn, lowering demand for GBP.
A softer pound increases the value in GBP of overseas assets (for example, global or US ETFs) and boosts the reported earnings of many FTSE 100 companies that earn a large share of their revenue abroad.
It’s important to note that long-term investors don’t need to base their investment decisions on individual interest rate cuts. A broad trend towards lower rates over the course of years, however, is worth keeping an eye on.
Money Market ETFs also drop
One inevitable result of interest rate cuts is drops in the targeted returns of Money Market ETFs. These ETFs typically invest in ultra short‑term government debt and other fixed income securities, with the aim of matching the Bank of England’s SONIA rate.
The SONIA rate is a benchmark that reflects the average interest rates being offered by banks in the UK. After peaking at 5.2% in 2024, the SONIA rate has gradually dropped as the Bank of England’s base rate has, down to 4% today.
Any further cut to the base rate will see Money Market ETFs target that lower rate. They still offer competitive returns, particularly when compared to savings accounts, but it’s important for investors to know the targeted returns of their ETFs.
As interest rates continue to come down over time, the targeted returns for Money Market ETFs will also fall. As a result, investors may want to consider alternative options in the future, particularly if high returns are the goal.
The bottom line
So, a UK interest rate drop this week is still relatively unlikely. In the event of a cut, however, investors might benefit from taking a look at their portfolio to ensure it’s still fit for purpose.
It’s generally not advisable to make decisions based on one rate cut, but a portfolio set up in mid-2024 will have been created under notably different circumstances to today.
And of course, there’s also every chance the Bank of England follows expectations and holds rates at 4%. We’ll be back after the announcement with our reaction.
Important information
Capital at risk. The value of your investments can go down as well as up, and you may get back less than you put in.
Tax treatment depends on individual circumstances and is subject to change. Scottish tax bands are different. ETF costs also apply.
This content is for information only and is not financial advice. If in doubt you may wish to consult a professional adviser for guidance.