What will happen to interest rates in 2025

Up, down, up, down (but let’s face it, mainly up!) – we've learnt how volatile mortgage rates can be over the last few years. But, what will happen to interest rates in 2025? Our Head of Product, Peter Stimson, shares his thoughts on what we might see over the next twelve months advising we should strap ourselves in for a bumpy ride.??

As I write we’ve had the usual roller coaster start to the year with swaps already deviating over 20 basis points in as many days, implying one additional rate cut in 2025 or, to be more accurate, just re-inserting? the rate cut the market took out when swaps went up in late December/early January!?

The slightly unexpected drop in CPI in December and particular to core CPI now means we are now very likely to get a cut to Bank Base when B of E meet on 6th Feb. With 2-year SONIA now at circa 4.25%, this is implying another cut in Feb, a cut mid-year, and a cut in early 2026.??

The big question is, however, are the markets correct about where the Bank Base rate is heading? A look back at a swaps over the last 3 years resembles, at times, an earthquake graph (okay, we do have Lis Truss at least partially to blame…) often with inaccuracies as to where rates and Bank Base rate ultimately ended up. Whilst, in a small part, this is down to markets not wanting to be the wrong side of a trade, it’s largely down to decisions being made on information at ‘point in time’, which can change very quickly afterwards.?

As we look ahead, the UK is facing some very unique challenges, all of which have the potential to create a lot of instability and move the rate needle quite quickly. This means that current assumptions could ultimately end up being quite wide of the mark.?

We currently have three key principle drivers of UK rates (and several smaller ones which for purposes of brevity we won’t go into here). They are as follows:?

Inflation - The Bank of England is tasked with bringing inflation down to under 2.0%. In December it was 2.5% and falling and importantly core inflation fell by 0.30%. ‘If’ inflation falls faster than perhaps some are predicting, this gives the B of E more rate cutting headroom – watch this space on 18th Feb for the next CPI pronouncement.?

The UK economy – Let’s be honest, economic growth is anemic, estimated at 0.10% for Nov 2024. On top of this, we still have the increase in employers' NI contributions to come in April which will be a further drag. Ask a Central Banker about their biggest concern and number one will probably be ‘Stagflation’, persistently high inflation and low/no growth. Cutting rates is a stimulus that may be an option, even if we are still above the 2.0% inflation target.?

Global macro-economic – Here, I may as well just write Trump/Musk – unpredictable, and unstable would probably sum it up (it would be interesting to be a fly on the wall to see how Trump, Musk, and Bannon get along!). With the potential of tariffs, and almost certainly higher US inflation and interest rates, it has the potential to impact on the UK in the form of higher bond yields and a stronger dollar (ultimately impacting GDP).?

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My best guess is that the bank will play the first half of the year cautiously, assessing the inflation and CPI data and seeing where Trump/Musk relationship with the UK progresses. In the second half, my expectation is likely to be a bit more room for rate cutting than is currently priced into the curve based on improved CPI numbers and an economy that, sadly, continues to underperform. So, whilst the markets see Bank Base at circa 4.25% by year end, I would anticipate a figure around 3.75%. Ultimately though this is a case of crystal ball gazing and it’s important to remember there is a long way to go and an awful lot can change!??

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