For all the hopes of steady and consistent interest rate cuts \u2014 which lower borrowing pressures on mortgage holders, investment costs for businesses, and the debt interest bill for the government \u2014 2025 was instead marred by a series of unforeseen and self-inflicted inflationary surprises. <\/p>\n
At the end of last year, the Bank was worried that inflation could climb back up to around 2.75 per cent. The reality was a peak of 3.8 per cent in September, which at one point was likely to top 4 per cent. What went wrong?<\/p>\n
Why are interest rates still high? <\/p>\n
The unexpected price shocks came mainly in the form of rising global food and commodity prices, caused by extreme weather events and poor harvests. In the UK, this resulted in food price inflation<\/a> breaching 5 per cent in August. In the worst hit categories of beef, butter, chocolate and olive oil, the average rate of inflation topped 15 per cent between the summer of 2024 and 2025. <\/p>\n Rising grocery prices are a problem for central bankers because shoppers are sensitive to the cost of supermarket trips, creating a sense of generalised inflation and a higher cost of living. The UK is more exposed to changes in global food and commodity prices than other countries in Europe due to its reliance on imports and the design of its inflation basket. Food prices, whatever their drivers around the world, matter in the UK. <\/p>\n Another quirk of the UK that drove up inflation this year is the power that regulators in areas like water, sewage and travel have to raise prices through a system of indexation rather than prices being set by the market. This created an inflation \u201chump\u201d from April, when the cost of many utility bills rose by over 8 per cent, although inflation in market-based services was around 3.5 per cent. <\/p>\n The UK is more exposed to changes in global food and commodity prices than other European countries<\/p>\n PIXELSEFFECT\/GETTY IMAGES<\/p>\n The final and most controversial factor contributing to stubborn inflation and keeping interest rates from falling was the government\u2019s decision to raise payroll taxes through national insurance rises on employers and a substantial lifting of the living wage from April 1. In December 2024, the Bank estimated the inflationary impact of the budget would be around 0.5 percentage points through rising wages and some companies passing on their payroll expenses to consumers. <\/p>\n Rate-setters were less certain about how the policies would affect the jobs market. The latest evidence from the Bank\u2019s surveys of business show around 40 per cent of firms said they would cut jobs and more than a third said they would raise prices. This combination of a slowing labour market \u2014 which traditionally requires lower interest rates \u2014 and the prospect of inflating prices \u2014 which require higher interest rates \u2014 has led the Bank to take a \u201cgradual and careful\u201d approach to monetary policy for most of the year.<\/p>\n What will happen to interest rates next year? <\/p>\n The tension between sticky prices and a slow economy with weak hiring has divided the nine-strong monetary policy committee all year. They are likely to be at loggerheads again on Thursday, forcing Andrew Bailey, the governor, to make the decisive vote to hold or cut interest rates before the end of the year. <\/p>\n Rachel Reeves has to convince more of the MPC to cut interest rates next year<\/p>\n ALAMY<\/p>\n Jack Meaning, a former Bank official and economist at Barclays, said Bailey<\/a> would switch his vote to support a narrow interest rate cut to 3.75 per cent. <\/p>\n The other four rate-setters who are worried about prices, including Huw Pill<\/a>, the Bank\u2019s chief economist, would remain unmoved, Meaning said. <\/p>\n Rachel Reeves has to convince more of the MPC to cut interest rates next year with a series of measures designed to induce disinflation in 2026. The government will cut green levies on energy bills, freeze fuel duty and keep rail fares unchanged \u2014 measures that could reduce headline consumer price inflation by 0.4 percentage points next year.<\/p>\n Some economists are not convinced the plans will work. The CBI, a business lobby, said the government\u2019s measures would have a 0.1 per cent effect on inflation, creating the room for just one more interest rate cut in 2026.<\/p>\n Financial markets \u2014 who make bets on the path of interest rates \u2014 also do not think the Bank will be carrying out significant easing over the next 12 months. They are pricing in two rate reductions at most, leaving the base rate to settle at around 3.25-3.5 per cent. Before 2022, the ten-year average for UK interest rates was 0.5 per cent. <\/p>\n What is going on in the rest of the world? <\/p>\n Investors are not just worried the UK won\u2019t get major monetary easing but are also repricing their expectations for the rest of the world too. December began with a sharp sell-off in government bonds over worries about the return of inflation in the US and Europe, coupled with neuralgic concerns about growing debt piles and fiscal deficits. <\/p>\n Bond prices fall and yields rise in an environment of higher global interest rates. Market interest rates matter for governments who have to service their debts and for mortgage holders, whose loans are derived from market prices. <\/p>\n![\"Woman](\"https:\/\/www.newsbeep.com\/ca\/wp-content\/uploads\/2025\/12\/\/8b412195-00a7-4204-8b25-ef9d1e703509.jpg\")
<\/p>\n![\"Rachel](\"https:\/\/www.newsbeep.com\/ca\/wp-content\/uploads\/2025\/12\/\/562ff8be-2c65-462e-9481-31df3e860a01.jpg\")
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