How Interest Rates Affect the UK Interest Rate With UK inflation stubbornly high, the Bank of England raised interest rates again this week. This puts more pressure on borrowers and will make it harder for the Government to bring inflation down closer to its 2% target.
But the impact of higher rates has yet to full felt, especially by those with a mortgage. This is causing concern to investment markets.
Inflation UK interest rate
Inflation is one of the biggest factors affecting the UK interest rate. When prices rise, borrowing costs increase too and that can dampen economic growth.
The UK is currently suffering from high levels of inflation, mainly due to the recent jump in energy prices and Russia’s war on Ukraine. Inflation is expect to peak at around 10%, but is like to fall back later this year after new Prime Minister Liz Truss’ government unveils a series of relief measures to help families and businesses cope with rising energy bills.
However, the slowing down of food price inflation means that it will take longer for CPI to fall back toward the Bank’s 2% target. That could force the Bank of England to raise rates again, and that would push mortgage rates up too. That is a big worry for people with variable and tracker rate mortgages, which are the most affected by base rate changes. It also raises the prospect that borrowers will be paying more for their home loans and protection products.
A major concern for central banks is a rapid increase in prices. This is why they use their toolkit of interest rate adjustments to help tame inflation by making it more expensive for people to borrow money for large purchases like cars and houses.
The April figures suggest that economic growth is picking up again. Combined with the renewed upturn in selling price inflation suggested by the flash PMI data, this is likely to put pressure on the rate-setters at the Bank of England to sanction another base rate rise this week.
A twelfth hike would take the UK base rate to 4.5%, the highest level since 2008. However, a growing consensus among analysts and economists is that this will be the last hike for some time to come, with lower energy costs and wages helping to bring inflation back towards the Bank’s target of 2%. This would then pave the way for a return to interest rate cuts in 2023.
The Bank of England
Last month the Bank of England (BoE) voted to raise interest rates by half a point, which was its biggest increase in 27 years. The decision came after a government relief package for energy bills and soaring food prices eased inflationary pressures and boosted consumer spending.
The BoE’s Monetary Policy Committee (MPC) also upgraded its growth projections in March, erasing a recession and forecasting that GDP will grow faster than it previously expected. Its members have also raised the odds that this Thursday’s rate rise will be the last.
However, with food prices soaring and wage inflation picking up, the MPC’s goal of bringing inflation back down to 2% remains challenging. And because monetary policy works with a lag, the full effects of this Thursday’s rise have yet to sweep through the economy. This could give the MPC reason to lift rates again in the future.
The Path of Bank Rate
After a smaller-than-expected fall in inflation this month, markets expect the Bank of England to push interest rates up further. This will mean a higher cost of borrowing for people with a mortgage and could push consumer prices even closer to the Bank’s target.
Inflation has been driven higher by soaring food prices and the impact of the Russia-Ukraine conflict. Those price rises are expected to be temporary but if they do persist it’s likely that the Bank will have to keep pushing up rates longer than had previously been expected.
At its latest meeting, the MPC voted 7-2 in favour of a further rate rise, putting base rates at 4.25%. That’s the highest level since 2008. However, if inflation continues to be stubbornly high then the MPC may need to raise rates even further. That would come as a bitter blow for those battling rising costs and soaring house prices, according to the ICAEW.