The Bank of England (BoE) cut interest rates from 5.25% to 5% last Thursday (Aug 1), making it the first rate cut since the 2020 pandemic.

Following the announcement, the value of the pound momentarily dropped to its lowest point in almost a month before recovering a significant portion of the losses, settling around 0.7% lower for the day at $1.2772. The FTSE 250 experienced a slight decline of 0.65%, yet remained near its peak levels since early 2022.

How will the UK stock market be affected?

After enduring the repercussions of Brexit, enduring a series of leadership transitions within the former Conservative administration, and grappling with the aftermath of ex-Prime Minister Liz Truss’ ill-fated 2022 mini-Budget, UK equities are currently undervalued while government bonds are lagging behind their American counterparts.

Historically, instances of rate reductions that did not lead to economic downturns have been succeeded by robust equity performance. The U.S. Federal Reserve’s rate cuts and the subsequent performance of the American stock market serve as a prime example. Data spanning back to the early 1980s indicates that following the first rate cut, the S&P 500 exhibited an average return of 14.2% over the ensuing 12 months, surpassing the typical 12-month return.

The FTSE 100 achieved record highs last month, and is currently trading below that threshold. It seems that markets have already “priced in” the changes.

In addition, small-cap stocks, such as UK penny stocks, will likely benefit the most from the BoE cut, as they are more sensitive to the rate environment than larger companies with established access to international financial markets.

What should you do?

Although rate cuts are usually a positive signal for the markets, it’s important for the investors to focus on the guidance provided by the central bank.

Given notable uncertainties, a thoroughly diversified portfolio will position investors favorably over the extended term.