The interest rate cut by the Bank of England to 5% could give business owners and mortgage payers hopes of returning to pre-pandemic low borrowing costs, but experts are saying that these higher rates are here to stay, with that, opening up possibilities for many to slip into financial stress.

The Bank of England slashed interest rates to 5% not so long ago, and millions of mortgage payers and business owners are now hoping this may be the signal for a return to cheap borrowing as enjoyed before the pandemic. Experts say higher rates could be around for some time and will cause financial pain to many.

Claire's Story

Claire, a maternity support worker from Portsmouth, moved into her house in January 2022 with a 1.99% fixed mortgage, for which she used to pay £1,042 a month. She says the payments now rise to £1,596.90 a month, which is proving a huge stress for her family. Claire and her husband are now struggling to cope with these rising costs for themselves and their four children.

"We had been hoping for some equity from our home before remortgaging in January 2024," she says. "Because we have had to fix our mortgage at 5.7 percent for another two years. I do wish those 2 percent loan rates would return."

How the Bank of England views the situation

On his part, Andrew Bailey, the governor at the Bank of England, opines that interest rates are not going to return to such ultra-low levels reached between 2009 and 2021 again. He believes that interest rates are unlikely to go as low again but will settle around pre-2008 levels without a big economic shock.

Economists refer to this as the equilibrium or neutral rate, which they estimate will reach 3.5% in three years. When translated to mortgage rates, it's more than 4.5% to 5%, a good bit higher than Claire and other borrowers would like to see.

What's Next for Interest Rates?

While it's made a small cut in interest rates, a close decision, it's thought there'll only be one more small cut this year. Indeed, interest rate setters—the Monetary Policy Committee—are being very careful. They want to allow the economy to grow but with inflation firmly at 2%.

Personal spending has been driving UK economic growth, which the MPC worries may be fueled by low interest rates and spiral into consumer spending, leading to an increase in inflation. They are looking to delay further changes until November or December while assessing these pressures on the economy, along with the government's budget set for October 30.

But Bailey also placed equal emphasis on the fact that the Bank needs to be careful not to cut rates too quickly or too much. He wants to squelch any hopes that interest rates might return to the old "normal."

The Equilibrium Rate

All that really remains is the neutral interest rate, which for the time being at least, remains a matter of conjecture. Some believe it could be as low as 3%, while others think it might be as high as 4%. This discussion hinges on the velocity with which the economy of the UK can grow without breaching the Bank's target for 2% inflation.

Yael Selfin, KPMG's chief UK economist, said: "If the Bank holds inflation at 2% and the economy grows at 1% a year, the equilibrium interest rate is 3%."

Currently, the CPI stands at 2%, and the Bank forecasts that it will rise temporarily to 2.75% before getting back to target by 2025.

Risks to Inflation

Several such events can throw a spanner in the Bank's calculations. For instance, if Donald Trump wins in the US and cuts military aid to Ukraine, that could prove to be a major reason behind wheat prices going up, which in turn will send food costs higher. Gas prices too may go up.

These could be further complicated by impending trade tariffs by the US against China. As things stand, many rich countries are now encouraging domestic alternatives to foreign-made goods, often more expensive and adding to inflation that forces central banks to keep interest rates high.

This could also raise the price of oil and gas in case of an escalation of the Middle Eastern conflict, thereby raising short-term inflation. In such a scenario, central banks would again raise interest rates to dampen consumer demand.

"Trade restrictions are a big threat, particularly if Trump wins the US election. In the long run, shortage of skilled labor might also drive wages and inflation higher," said Lorenzo Codogno, former chief economist at the Italian central bank.

Global Impact

It is not unique to the UK. The euro area has less solid growth prospects, which cuts the neutral interest rate to 2% to 2.5%. The same rate, at the US Federal Reserve, will be around 3%-3.5%.

"Because all big economies are suffering from the retirement of the baby boomers, the inflationary pressure for a lack of skilled workers can be seen," said Dario Perkins, an economist at TS Lombard. And central banks are proposing small rate changes in response to the situation.

Hopes from Claire's

Claire, of Portsmouth, has two years before she needs to remortgage. Her monthly interest bills may fall, but they are unlikely to return to the low rates she was initially getting.

"We're just hoping things turn around and that we can get some financial control back," Claire said. "But it's going to be a long two years. If things don't get any better, selling our home might be our only option."

While there is some hope for mortgage payers and business owners following the recent interest rate cut by the Bank of England, many experts argue that the current higher rates are likely to stay, with many financially struggling still.