What will happen to interest rates in 2025?

Important information - the value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

Inflation 

The Bank of England’s primary objective in setting interest rates is to keep inflation under control. It has a target, set by the government, of keeping inflation within a range of around 2% a year. If it believes inflation is likely to trend higher than that it will keep rates higher to remove demand from the economy and help pull prices down. If inflation is running below that it can cut rates to leave more money and demand in the economy to help growth and bring inflation back up to target. 

This is not a short-term exercise - the Bank will make inflation forecasts covering several years and set its rate policy accordingly. For this reason, there can be times when rates seem high despite inflation being on or near target - it’s what the Bank thinks will happen in the future that matters. 

Right now, inflation (Consumer Price Index) is running at 2.6% in the year to November. That’s close to target but the reading has ticked higher in recent months and has come in slightly above where economists have expected. The Bank’s own forecast is for inflation to rise to 2.75% by the second half of 2025 before heading back down again.¹ 

Rates can still fall in that time, but if inflation begins to show up as being higher than the Bank expects then interest rate cuts could be delayed and rates will stay higher for longer. 

Growth 

Growth in gross domestic product (GDP) is the other major metric that the Bank of England watches closely. When growth is higher this tends to feed through to a higher level of demand in the economy which can often mean upward pressure on inflation. If growth is weak then this tends to mean consumers have less confidence and job security, leading to less spending, lower demand and eventually lower prices. 

The growth numbers in 2024 have been weak, with the second half of the year being particularly disappointing. GDP grew by just 0.1%² in the third quarter of the year and the figure for October - the first month of the fourth quarter - has shown GDP actually shrinking by 0.1% month-on-month³. 

This weak growth removes inflationary pressure and means the Bank has more room to cut rates. 

Experts views 

There is never a shortage of professional voices waiting to give their view on what they think will happen with rates, growth and inflation. Recent estimates for rates include those from the Organisation for Economic Co-operation and Development (OECD), which said this month that it expects UK rates to fall less quickly over the next two years. 

The body blamed measures from the recent Autumn Budget that will rapidly increase spending, with tax rises only recouping a fraction of what the government plans to spend and borrowing making up the rest. This will mean markets will expect a higher rate of interest to lend to the government.   

Analysts at Goldman Sachs have been more bullish that rates will be cut rapidly next year, forecasting the Bank rate to drop to as low as 2.75% by the end of 2025. In a research note Goldman Sachs said:  “Our findings suggest that the Bank rate remains notably restrictive and – together with rapidly falling inflation and dovish MPC commentary – reinforces our view that the Bank of England will ultimately lower rates more than priced.” 

Meanwhile, Capital Economics, the economic think tank, have forecast the Bank of England Rate reducing rates to 3.5% by early 2026. 

Source: 

¹Bank of England, 7 November 2024  
²ONS, 15 November 2024  
³ONS, 13 December 2024