Interest Rate Rises from the Bank of England: Reasons and Implications

What is happening?

The Bank of England has raised interest rates for the 10th time in a row, causing the base rate, the rate which all other UK banks must follow, to reach its highest level in 14 years. This is intended to combat the rising inflation rate, which reached 10.1% in January, over five times the Bank’s target of 2%. Inflation, which refers to a rise in the general price level, has led to the current cost-of-living crisis due to the rising price of necessities, with housing and bills alongside food and drinks being the largest contributors to the inflation rate. Prices have risen worldwide after governments eased Covid restrictions, causing a surge in consumer demand. Another factor is the war in Ukraine, which has pushed oil and gas prices up, leading to the soaring cost of energy, and reduced the amount of grain available, driving food prices up.

Inflation Rate (Consumer Prices Index)

Latest Changes

Following the latest meeting of the Bank’s monetary policy committee (MPC), the benchmark rate has risen from 3.5% to 4%. More rate rises are likely to come, with some analysts speculating that it will peak at 4.5% in the summer. The MPC meets eight times a year to decide interest rate policy.

Base Interest Rate

Source: BBC

Why?

The intended impact of the policy is to lower inflation by making it more expensive to borrow money. People will be encouraged to borrow and spend less, and save more. This will help reduce inflation caused by the surge in consumer demand. Since wages rose by 6.7% from September to December 2022, which would raise demand for consumer goods, the Bank maintained that further interest rate changes were needed to effectively reduce inflation.

However, this is a tricky balancing act as higher interest rates can lead to a decline in economic growth, as they reduce consumer demand. This could worsen the recession the UK is expected to enter this year. The Resolution Foundation thinktank said that statistics show that the UK is in the midst of the weakest 20-year period of growth since before the second world war and the Bank’s policies will only worsen this. Nonetheless, Chancellor Jeremy Hunt, whose recent tax rises are also expected to reduce economic growth, “supports the Bank’s actions” in prioritising inflation levels as they are “the biggest threat to living standards today”.

Who does this affect?

Mortgage Rates

The rate increase will have significant implications for borrowing costs. Many homeowners on variable or tracker mortgages will be forced to pay more expensive monthly repayments. According to the Bank of England, up to four million households face a higher monthly mortgage bill this year. Around three-quarters of mortgage customers have a fixed-rate mortgage and will not be affected by the interest rate rise. However, those seeking to buy or remortgage a house, estimated to be around 1.8 million this year, will have to pay much more than if they had taken out the same mortgage a year ago. The Bank’s interest rates also influence the rate charged on credit cards, bank loans and car loans. Ahead of this decision, the average interest rate on bank overdrafts was 19.77% and 19.55% on credit cards. Lenders may decide to drive up their interest rates further, in anticipation of higher base rates in the future.

On the other hand, deals being offered for savings in banks are better than anything seen in years. Some banks now offer up to 7% interest on savings accounts. As some widely held accounts, such as Barclays and Santander easy access accounts, are lagging behind with just 0.5-0.6% interest, analysts recommend people to shop around for a better savings rate. Although

Source: BBC savers are receiving a higher return on their money, the rates are not keeping up with the inflation rate, meaning the purchasing power of savings is falling.

Looking Ahead

With the current policies, the Bank of England expects the inflation rate to fall rapidly this year to 3.5% by the end of the year, and then 1% in 2024. However, this may come at a cost as the soaring interest rate could have harmful consequences for ordinary people facing mortgage and credit payments and exacerbate the coming recession.

Key Terms:

• Inflation - a rise in the general price level in an economy.

• Interest - the price of borrowing money.

• Base rate - the interest rate set by the Bank of England for lending to other banks.

• Cost of living - the level of prices relating to a range in everyday items.

• Mortgage - a type of loan used to purchase or maintain a home.

Further Reading:

• Interest Rates: Different Types and What They Mean to Borrowers - Investopedia

• What does the latest rise in interest rates tell us about the UK economy?Economics Observatory

• What do interest rate rises mean for you?

-The Times