As the headlines cheer the Bank of England’s rate cut to 3.75%, economists are issuing a reminder about the “lag effect.” Monetary policy is famously described as operating with “long and variable lags,” meaning a rate cut today might not be felt in the real economy for 18 months. The 0.25% reduction is a positive step, but it won’t magically reverse the 0.1% GDP contraction by January.
This delay is due to the structure of the UK economy. Most mortgages are now on fixed terms, meaning millions of homeowners won’t feel the benefit of this cut until their current deal expires, potentially years from now. Similarly, business investment decisions are made on long cycles; a factory planned today won’t open until 2027. The Bank is effectively steering a supertanker—it turns the wheel now, but the ship turns later.
The dissenting “hawks” on the MPC used this lag argument in reverse. They voted to hold rates because they believe the full impact of previous hikes hasn’t been felt yet. They worry that cutting now, before we know the full damage of the inflation fight, is reckless. Conversely, the “doves” argue that if we wait for the data to improve, we will have waited too long.
For the government, the lag is a political problem. They need voters to feel richer before the next election cycle heats up. Chancellor Rachel Reeves is talking up the “fastest pace of cuts” to try and bring forward the psychological benefit, even if the financial benefit is delayed.
Ultimately, 2026 will be defined by the actions taken in 2025. The stagnation we are seeing now is the result of rate hikes from last year. The recovery we hope for will be the result of the cuts happening today. It is a waiting game, and patience is in short supply.