British consumers were able to breathe yet another sigh of relief last week as the Bank of England (BofE) announced another cut to the base rate, which has also ushered in a new era for the UK banking sector.
The reduction in interest rates from 5% to 4.75% last Thursday (7 November), the second interest rate cut of the year and a move widely anticipated for the past couple of months. The rate essentially governs how much interest people have to pay back on borrowed money, like mortgages.
For the general public, such as mortgage holders, and the government, this is good news. In the case of consumers, the obvious benefit is that they now need to pay less on loans and mortgages, meaning less of a hole being burned in their pockets.
For the government, it is an indication that the economy is continuing to improve after two successive instances of economic growth this year and a reduction in inflation to 1.7%, the first time in years it has fallen below the BofE target of 2%.
It is important to note, however, that the BofE does expect inflation to rise slightly over the coming months due to the government’s budget, which focused heavily on public investment and raising £40bn through tax changes.
Rachel Reeves, Chancellor of the Exchequer, said: “Today’s interest rate cut will be welcome news for millions of families, but I am under no illusion about the scale of the challenge facing households after the previous Government’s mini-budget.
“This Government’s first Budget has set out how we are taking the long-term decisions to fix the foundations to deliver change by investing in the NHS and rebuilding Britain, while ensuring working people don’t face higher taxes in their payslips.”
Banks, the budget and the base rate
The UK’s banks must now act quickly to get ahead of one another, with the drop in interest rates potentially giving traditional banks an opportunity over the challenger banks which have been making themselves a nuisance over recent years.
Graeme Carmichael, Executive Director at Capco, a financial services management consultancy, tells Payment Expert that the change in inflation “will pose a fresh set of challenges for the banking industry, as players seek to remain competitive in a falling interest rate environment”.
“Challenger banks who have emerged in the past few years of rising interest rates are particularly under pressure, as they fight to remain competitive against a backdrop unprecedented to them,” he continues.
Challenger banks have, true to their moniker, been challenging the traditional banking sector a great deal lately. Revolut, which secured a UK banking licence this year after nine years of activity, is now Euriope’s most valuable fintech. Monzo, also founded in 2015, has been reporting rapid growth across both consumer and business accounts over the past year.
According to the Competition and Markets Authority (CMA)’s latest customer satisfaction survey, challenger banks are getting a much warmer reception from customers.
The top two rated banks were challengers Monzo and Starling, with the third place spot shared between fintech Tide and traditional bank Handelsbanken. In contrast, the three lowest ranked current account providers were the Co-operative Bank, Virgin Money and the Royal Bank of Scotland (RBS).
However, as Carmichael notes, these traditional banks do have a lot more experience of changing market dynamics than their neobank challengers. The recent drop in interest rates could help level the playing field with the profitability of well-established banks and new digital banks alike feeling the squeeze.
“Banks typically earn much of their income from the spread between interest on loans and deposit rates, so a lower interest rate environment will naturally narrow this spread, putting pressure on earnings,” Carmichael continues.
“The rising interest rates that we have seen since early 2022, have understandably seen banks and shareholders develop higher profitability expectations.
“With pressure to maintain these expectations and remain competitive against their peers, it is important that banks take measures now to protect their margins and proactively manage their cost-to-income ratios.”
Financial services stakeholders have a lot of political developments on their plates at the moment. Firstly, a week before the interest rate was cut the Labour government announced its first budget in 14 years.
The budget focused heavily on investment, including some support for research which fintech may want to keep a close eye on. Meanwhile, to fill a £40bn gap in public finances the party has raised capital gains tax and company’s national insurance contributions, giving businesses some more numbers to crunch.
Reviewing operational and technological processes could help in this regard, Carmichael believes. Business Process management (BPM), Business Process Outsourcing (BPO) of functions like tech engineering, and general improvements to tech infrastructure and use of Artificial Intelligence (AI), could help savings and decision making.
“Exploring digital and self-service options, as well as refining product offerings, could further support banks’ efforts to remain competitive in a lower interest rate environment,” he says.
On the other side of the Atlatnic, the election of Donald Trump has presented another political development to contend with – whether this is a challenge or not depends on the nature of one’s business.
For crypto and digital asset companies, the Republican’s presidential victory is undoubtedly a positive. His crypto-friendly policies are great news for the sector, which has seen values rise ever since the polls closed last Tuesday.
On the other hand, Trump is a huge fan of tariffs, going as far as to call himself the ‘Tariff Man’. This might not be great news for UK fintechs hoping to sell products and solutions to US banks and financial institutions, such as those specialising in Open Banking.
“When the UK’s expertise in Open Banking, having created the blueprint, is combined with the super-sized US market scale, the effect is transformative. It marks the positive shift of the inflection point that the industry has been working towards,” says Helen Child, CEO of Open Banking Excellence (OBE).
“For those in the fintech, Open Banking and wider financial services community, all eyes will now be keenly focused on the likely future direction of policy in the US following Donald Trump’s victory.”
Turning away from the grandeur of geopolitics, however, it is important to focus on what the UK budget and bank base rate mean for the average consumer – the ones whose payments underpin the volume this industry processes.
More money in their pockets may prompt customers to spend in other areas, potentially inflicting trends.
Moreover, if people feel that the economy is turning in their favour under Labour, they will be more likely to give the party a second chance in government, further validating its various policies and legislative plans for the financial services sector overall.
Jerry Mulle, UK Managing Director of Ohpen, a core banking platform, summarises the impact of the base rate and the budget on consumers, stating that last week’s cut ‘should be welcome news for homeowners and prospective buyers’.
“The move should signal easing inflation rates and in turn, lower mortgage rates. However, mortgage owners and applicants are not out of the woods,” he adds.
“Last week’s Autumn Budget announced a £70bn increase in spending which will have forced the BoE to take caution.
“In real terms, the Budget will also put added pressure on households and those already making mortgage payments, or planning to apply for a mortgage, as fixed mortgage rates are expected to remain high.”
