May interest rate cut: what now?

The value of your investments and the income you receive from them can go up and down, and you may get back less than you invest. Any examples are for illustration purposes only.

Hot on the heels of the Federal Reserve keeping interest rates steady across the pond, the Bank of England just dropped rates in the UK by 0.25% to 4.25%, the lowest level since April 2023.

The step down was widely expected today, after UK inflation measures across the board dropped in March. The big question now is what the path for interest rates looks like for the rest of the year.

Depending on who you ask, we should expect two or three more cuts before the end of the year.

Coming into April, a quarterly cut schedule to bring interest rates down to 3.75% by December had been baked into predictions but the onset of US tariffs have muddied the waters. As they’ll naturally drive prices up for buyers, tariffs are likely to be inflationary, which potentially points to central banks around the world keeping rates higher in a bid to combat price rises. The problem is, as a barrier to trade, there’s a good chance they could slow economic growth too. It’s why parts of the market now expect three more cuts this year instead of the previously predicted two, as some think the Bank of England will step in to lower rates faster than planned to ease pressure on the economy.

Read more:

Top 10 stock buys in April 2025 on Robinhood UK

How much do you need to earn to be rich?

Is it time to sell the Mag 7?

On the inflation side, UK figures came in better than expected in March but April’s raft of price rises marred the downside surprise. ‘Awful April’ brought with it a huge hit to household budgets with rises in council tax, phone bills, water rates and a lot more consumer expenses so we’re likely to see inflation get worse over the summer before it gets better. It’s been flagged before that the BoE expects inflation to hit 3.7% later in the year before receding and the market has been banking on the central bank looking through the near-term data with a view to any rate cuts kicking in with a lag. The big positive is services inflation budging off its stubborn 5% level. Given the UK is a service-based economy, if it plays ball for the rest of the year and doesn’t stay stuck in the 4.5-5% range, that rate schedule will look all the more likely.

Investors in equities normally cheer on lower interest rates as the market tends to use them as the discount rate in their stock valuation models. The lower the rate, the more attractive a company’s future earnings looks today. It means growth stocks (think tech), whose growth is priced out far into the future, can start to look a lot better.

Companies also have to pay less on any loan repayments they have, which puts less pressure on profits. Typically, small and mid-cap companies get less favourable lending terms than their large cap peers, so a steady stream of cuts to interest rates can help these groups in particular.

Falling rates also tend to make shares more attractive compared to cash savings and bonds, whose interest rates erode along with the wider rate picture. In the aftermath of the global financial crisis when rates were nailed to the floor, income seekers were forced to take a step onto the risk ladder, and into shares, as cash and bonds suddenly started offering paltry returns.

With two or three cuts possibly coming down the line, it’s worth asking what could derail the “gradual and careful” pace the BoE has in mind. The "past few weeks have shown how unpredictable the global economy can be" was the warning from governor Andrew Bailey today and we may well have a bumpy ride in the near-term, as the world digests the new trade environment.

Supply chains are more globalised than ever, meaning it’s not quite as simple as swapping a supplier to get round the threat of tariffs. JD Sports has already flagged how much confusion mitigating tariffs could cause, as it is a UK business, with a growing footprint in the US, whose main product lines (Nike) are manufactured in Asia. And that’s without any geopolitical tensions spilling over.

UK service inflation could also be the fly in the ointment. It’s an important measure for the BoE so if services get caught up in the tariff conversation and stoke inflationary flames, that downward rate trajectory could grind to a halt.

However, if the UK can navigate the current trade war storm, keep inflation on its downward slope and see a boost to gross domestic product (GDP) this may well prove to be the turning point for interest in UK companies.

Important information

When investing, your capital is at risk. The value of your investments, and the income you receive from them, can go down as well as up and you may get back less than you invest. Forecasts aren’t a reliable guide to future results or returns.

Make sure to do your own research on what investments are right for you before investing or consider seeking expert financial advice. Please note that this article is meant for information and does not constitute any financial advice. This is not an offer, recommendation, inducement or invitation to buy, sell, or hold any securities, or to engage in any investment activity or strategy.