The Bank of England's rate-setting committee has cut interest rates to 5.25% from 5.5% amid signs that the UK economy is slowing down.
The Bank is worried about rising food and energy prices
Analysts had widely predicted the move, which followed recent cuts in the US, where the Federal Reserve has slashed its borrowing costs to 3% from 4.25%.
However, the Bank of England signalled it was unlikely to be as aggressive because of fears over rising prices.
Several mortgage lenders said the rate cut would be passed on to borrowers.
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The Bank said it needed to ensure that growth and inflation were balanced.
Thursday's rate decision came shortly after E.On became the fifth major power company to raise gas and electricity prices this year as many food and staples costs have been increasing both in the UK and globally.
In its statement, the Bank said: "Inflation at 2.1% in December was close to the 2% target, but higher energy and food prices are expected to raise inflation, possibly quite sharply, in the coming months."
"The Committee needs to balance the risk that a sharp slowing in activity pulls inflation below target in the medium-term against the risk that elevated inflation expectations keep inflation above target," it added.
The Bank warned that it may be necessary to sacrifice some economic growth and consumer demand in order to bring inflation back under control.
It added: "Some slowing of demand growth, by reducing the pressure on capacity, is likely to be necessary to return inflation to target in the medium term."
However, some analysts warned that the Bank may have little choice but to cut rates again this year should economic conditions deteriorate further.
"The slowdown in the UK economy has so far been modest, and, with inflation above target, the MPC appears determined to proceed with caution," said Andrew McLaughlin, chief economist at RBS.
"Nevertheless, economic headwinds are becoming stronger and a more aggressive policy response may yet be required."
Some observers had voiced concern that not all mortgage lenders would pass the interest rate cut onto their customers, limiting the cut's impact on the economy.
Many banks have already said they will pass on the cut. Halifax, Nationwide, Abbey, NatWest and Royal Bank of Scotland have announced they will reduce their standard variable rates.
Others had said in advance of the announcement that they would pass on the rate cut in full.
These include Lloyds TSB and its Cheltenham & Gloucester unit, Barclays' mortgage arm the Woolwich, HSBC and First Direct.
Many of them will not cut their rates for existing borrowers until 1 March, with HSBC not cutting until 7 March.
While the rate cut is good news for many mortgage holders, interest rates will also be cut for savers.
Ben from Leeds told the BBC that the rate on his individual savings account (ISA) was cut by a quarter of a percentage point "straight away".
"I will now save more money to compensate," he said. "I won't be spending more in the shops, I am cutting back on things and being more careful."
Sam from Nottingham explains that the cut in interest rates will also have an impact.
"A quarter-point cut means a loss of £30 a month in my retirement income," Sam explains.
"This is a serious matter - I need savings to supplement my pension."
The employers' organisation the CBI welcomed Thursday's rate cut and said it was pleased there had not been a bigger reduction.
"It is clear that it is a delicate balance with inflation pressures," said the CBI's Ian McCafferty.
"A quarter point now and then watching very carefully for how inflation develops in the coming months is the best strategy."
But the British Chambers of Commerce disagreed.
"Threats to growth are much more acute now than risks of higher inflation, and we would have welcomed a bold UK move to 5% today," said its economic adviser David Kern.
Trade union umbrella body the TUC also welcomed the decision.
"Homeowners will be pleased at the prospect of lower mortgage payments and UK manufacturers will look forward to paying less when they want to borrow to invest," said TUC head of economic and social affairs Adam Lent.