Base Rate Drops Below 4% as Bank Signals Caution Ahead

Base Rate Drops Below 4% as Bank Signals Caution Ahead

The Bank of England has cut the Base Rate to 3.75%, crossing below the psychologically
significant 4% threshold for the first time since early 2023. It marks the fourth cut this year
and brings borrowing costs to their lowest level in nearly three years, a significant retreat
from the 5.25% peak reached in August 2023.

But the narrow 5-4 vote that delivered it tells you everything about what comes next: future
cuts will be harder fought, and the pace of change is slowing.
Governor Andrew Bailey needed to switch his vote from November's hold to support this
reduction, and his message was clear. "We still think rates are on a gradual path downward,
but with every cut we make, how much further we go becomes a closer call."

Why Now?
The decision reflects improving economic conditions. Inflation has dropped to 3.2% in the
year to November, down from 3.6% in October and now at its lowest level since March.
Bailey said we had "passed the peak of inflation," and crucially, the Bank now believes the
headline rate will be "closer to target by April, rather than 2027", a significant acceleration in
their timeline.

The labour market is also softening. UK unemployment rose to 5.1% in the three months to
October, up from 4.3% a year ago, the highest level since January 2021. That easing
pressure gives the Bank more room to cut, though they're clearly moving cautiously.
Markets have responded by scaling back expectations for 2026, pricing in just one further
quarter-point cut, and not until June.

What This Means for Mortgage Costs
The good news is that mortgage rates have been falling steadily throughout 2025, and
they're now meaningfully cheaper than at the start of the year. Two-year fixed rates have
dropped from 5.06% to 4.31%, and five-year fixes from 4.82% to 4.39%.

More significantly, two-year fixes are now cheaper on average than five-year deals, a
reversal of the pattern we've seen for the past few years. Back in August 2023, two-year
rates were almost 0.5% more expensive than five-year fixes because markets expected
rates to fall sharply, making longer fixes safer for lenders. Now that future cuts look less
certain, two-year deals have become the better value option for many borrowers.

A typical borrower taking out a fixed rate mortgage today compared to the start of 2025 will
save around £25 per month (£300 per year) for every £100,000 borrowed over 25 years. If
rates continue falling as expected and the average mortgage rate reaches 4.3% during
2026, those savings could increase to £38 per month (£456 per year) per £100,000
borrowed.

The Reality Check

Here's the important context: whilst mortgage rates are falling, they're not falling as quickly
as the Base Rate itself, which has dropped a full percentage point over the past 12 months.
Average mortgage rates have historically tracked around 0.8 percentage points above the
Base Rate, which suggests we're heading towards a world of 4% to 4.5% mortgages in a 3%
to 3.5% Base Rate environment.

That's meaningfully lower than today, but it's still substantially higher than the ultra-cheap
borrowing many households became accustomed to during the 2010s and throughout the
pandemic. The days of sub-2% mortgage rates aren't coming back.

The Big Challenge for 2026
Around 1.8 million fixed rate mortgages are due to expire next year, according to UK
Finance. Many were taken out at historically low rates, and as these borrowers refinance
onto significantly higher rates, the adjustment will continue to ripple through household
finances. The rate-cutting cycle may be helping, but it's not eliminating the payment shock
facing those coming off deals struck in 2020 or 2021.

What Happens Next
Paul Hardy, managing director at LSL Estate Agency Franchising, puts it well: "Dropping
below 4% is psychologically significant for buyers and sellers, restoring confidence after a
cautious few months. While it won't transform conditions overnight, it signals improving
stability, and we expect lenders to respond with sharper products, setting the stage for
renewed market activity heading into 2026."

The timing works in the market's favour. With the Budget and almost Christmas now behind
us, lenders have been cutting fixed rates for several weeks, and this latest Base Rate
reduction should add momentum as we move into the New Year. Both Savills and Rightmove
are predicting modest house price growth of around 2% in 2026, not spectacular, but steady.

The message for 2026 is clear: rates are heading lower, but they're settling at a new normal
that's higher than the recent past. For buyers, sellers, and those refinancing, it's about
adjusting expectations and making decisions based on where rates actually are, not where
we wish they'd go.