The governor of the Bank of England, Andrew Bailey, has said he expects interest rates to fall gradually but warned consumers not to expect a return to near-zero levels. Bailey said he was “very encouraged” by the downwards path of inflation and “therefore I do think the path for interest rates will be downwards, gradually”. Last week, the Bank kept borrowing costs on hold at 5%. Bailey told the Kent Messenger he did not expect rates to return to the historic lows close to zero last seen four years ago, and his “best guess” was that it would settle “at a neutral rate”. The neutral rate of interest is the level at which monetary policy is set for stable prices and is neither stimulating nor restricting economic growth. After the 2008 financial crash, central banks believed interest rates needed to be at or near zero to maintain economic growth. The neutral rate over the next decade, barring a financial crisis, is expected to be nearer 3%. Asked where interest rates would settle, Bailey said: “Will we go back to the very low near-zero interest rates that we had until not that long ago? “My answer is I would not expect that because what caused interest rates to go that way it was, among other things, two very big shocks to the economy.” Bailey’s comments are likely to disappoint mortgage holders who are on course to refinance their loans over the next few months and were hopeful that rates would fall quickly, as in the US where the cost of borrowing is expected to drop significantly over the next year. UK banks are expected to engage in a mortgage price war as interest rates come down. Britain’s biggest building society, Nationwide, said this week that it plans to let first-time buyers borrow up to six times their earnings. The chancellor, Rachel Reeves, may also need to account for higher interest rates on public borrowing than was previously expected when she delivers her first budget on 30 October. Foreign exchange markets reacted to Bailey’s comments by sending the pound to a fresh two-and-a-half-year high on foreign exchange markets. The prospect of UK rates remaining higher than the US in 2025 meant sterling extended a recent rally to hit $1.337 for the first time since March 2022. Against the euro, the pound has also increased sharply in value over the last month, to almost €1.20. Bailey’s comments appeared to show the Bank would continue its policy of modest cuts in interest rates over a long period, much as it did when it raised the cost of borrowing in small increments when inflation started to rise in 2021. The central bank reduced UK interest rates by a quarter of one per cent in August to 5% and financial markets expect a further 0.4 percentage point cut in November. The US Federal Reserve cut its main interest rate by 0.5 percentage points last week – its first cut in four years – and is forecast to slice a further three-quarters of a percentage point by the end of the year. Inflation has fallen from above 10% in 2022 to 2.2% in the latest figures for August. However, most of the reduction in inflation has come from falling goods prices, while services inflation remains well above the Bank’s 2% target. The financial markets predict UK interest rates could fall to 4.5% by the end of this year, and to 3.5% or lower by the end of 2025. Asked about the impact of Brexit, Bailey said “there will be some short-term painful effect on trade”. “But over a longer period of time the compensation for that is that trade will be redirected. But it can be particular impactful on small businesses and for some of them that’s just not viable,” he added. He also said that he had “never actually met Liz Truss”, the former prime minister, who revealed in April that she considered sacking Bailey as part of a drive to dismantle an “economic establishment” that she says helped to bring her down. “I think it’s part of being in public life that you have to accept there will be plenty of comments,” Bailey said.