How Much Lower Will the Bank of England Go?

The Bank of England's (BoE) monetary policy trajectory in 2026 will be a defining factor for the UK's economic and financial landscape. With inflation cooling and the labor market weakening, the BoE has signaled a shift toward easing, culminating in a December 2025 rate cut to 3.75%. By year-end 2026, the Monetary Policy Committee (MPC) is projected to reduce rates further to 3.25%, albeit at a slower pace, as the scope for cuts narrows according to economic forecasts. This trajectory raises critical questions: How much lower will rates go? And what are the implications for mortgages, equities, and the pound?

The Path of Rate Cuts: A Gradual Easing

The BoE's August 2025 Monetary Policy Report outlined a path where the Bank Rate would decline to 3.5% by mid-2026, aligning with market expectations. However, the MPC's internal divisions-evidenced by a 5-4 vote in December 2025-highlight lingering concerns about inflation persistence according to ING analysis. While core inflation has fallen to 3.2%, the BoE remains cautious, balancing the need to support growth against the risk of undershooting its 2% target. Analysts at ING and Deutsche Bank anticipate two to three cuts in 2026, with the terminal rate likely settling at 3.25%. This gradual approach reflects the BoE's prioritization of stability over aggressive easing, particularly as rates become less restrictive.

Mortgage Markets: Relief for Borrowers, Challenges for Lenders

The easing rate path is expected to bring significant relief to UK households. Mortgage rates, which have hovered near 5% in 2025, could fall to as low as 3% by late 2026, according to industry experts. A more conservative estimate suggests stabilization around 3.5%, driven by improved affordability and refinancing demand according to RBC wealth management. For first-time buyers and existing homeowners, lower rates will reduce monthly payments and unlock equity, potentially boosting housing demand. However, lenders may face margin compression as fixed-rate mortgages become less profitable. The Bank of England's own projections indicate that the easing cycle will support housing market activity, though risks remain tied to broader economic conditions according to BoE explainers.

Equity Valuations: A Tailwind for UK Markets

UK equities, already trading at a discount, stand to benefit from the BoE's accommodative stance. The FTSE All-Share Index is currently valued at 12.5x 2026 consensus earnings, reflecting undervaluation relative to global peers. Goldman Sachs Research argues that lower borrowing costs and a softening labor market will create a favorable environment for equities, particularly in sectors sensitive to consumer spending and business investment according to financial analysis. Additionally, the easing of monetary policy is expected to reduce bond market risk premiums, indirectly supporting equity valuations. However, the magnitude of these gains will depend on the pace of inflation normalization and the government's fiscal policies, which could introduce volatility.

Currency Positioning: GBP Under Pressure Amid Diverging Policies

The pound's trajectory in 2026 will hinge on the BoE's rate cuts relative to other central banks. The Federal Reserve, while also easing, has signaled a more measured approach, with the Fed Funds Rate projected to remain in the 3.5%-3.75% range. Meanwhile, the European Central Bank (ECB) may pivot to a hawkish stance, creating a stark divergence in policy paths. This dynamic is likely to weaken the pound against both the dollar and the euro. UBS forecasts EUR/GBP to rise to 0.8800, reflecting the reduced carry advantage. Investor flows will further exacerbate downward pressure, as capital shifts toward higher-yielding currencies. A weaker pound could boost UK exports but risks reigniting inflationary pressures, complicating the BoE's balancing act.

Conclusion: Navigating the New Normal

The BoE's 2026 rate-cutting cycle will serve as a critical test of its ability to navigate a fragile economic environment. While lower rates will provide relief to households and support equity markets, the pound's vulnerability to global policy divergence underscores the risks of an uneven recovery. Investors must remain attuned to the interplay between inflation, fiscal policy, and international monetary conditions. As the BoE edges closer to its terminal rate, the focus will shift to how effectively these cuts translate into sustainable growth without compromising price stability.