The Bank of England increased interest rates by 0.5% in August 2022, which is the largest increase in 27 years. This is the sixth increase in a row, which is part of the government’s scheme to lower inflation. The last time rates were this high was during the 2008 recession.
These increases have had a big impact on various areas, including mortgages, borrowing and savings. While some people can benefit from the increases, other people may struggle with rising repayment costs.
In this guide, we’ll look at why interest rates have risen and how they can help lower inflation in the coming months. We’ll also look at the Bank of England’s prediction for interest rates and inflation in the coming months and years.
Why have interest rates gone up?
The Bank of England is tasked with keeping the rate of inflation at 2%. To achieve this, the Bank of England adjusts interest rates accordingly. By raising interest rates, prices stop rising as quickly, which helps to slow and reduce the rate of inflation.
The Bank Rate is the UK’s key interest rate and influences all other UK rates. This includes rates for loans, mortgages and savings accounts. Between the end of March 2020 and December 2020, the Bank Rate was 0.1%. It has been steadily rising ever since and rose from 1.25% (between 7 June to 2 August 2022) to 1.75% on 4 August 2022.
Continue reading to find out how the rise of interest rates could affect you and how you can prepare for further increases.
Why is inflation so high?
There are many factors that have influenced the rising inflation rate. Increasing energy prices is one of the main reasons which has been influenced by Russia’s invasion of Ukraine. This is because Russia is one of the world’s largest producers and exporters of gas and oil. Although Russia doesn’t supply gas to the UK, the country supplies it to a large number of other European countries. Gas prices have increased on the international market as a result of the uncertainty surrounding the war, as has the price for UK natural gas.
The UK has witnessed price increases for petrol and domestic and commercial energy bills. Food prices have also risen, as both Russia and Ukraine are important suppliers of agricultural products such as wheat.
Prices for goods from abroad have also been steadily increasing, which is largely due to COVID-19. During the recent pandemic, people started to buy more products than usual. However, suppliers struggled to get these goods to customers due to labour and material shortages, which led to increased prices.
Businesses in the UK have also started charging more for products to help cope with the increased prices they face. There are also a large number of job vacancies that companies are struggling to fill because fewer people are seeking work following the pandemic. To attract job applicants, companies are offering higher salaries which are adding to their expenses.
Will interest rates continue rising?
It’s expected that rising prices could push inflation to 13% in the near future. Interest rates are impacted by the current state of the economy, as well as the estimated inflation rate for the next few years. There is no way to know exactly how high the rate of inflation will go, although it is expected that the rate won’t exceed the incredibly high levels that the country has witnessed in the past, such as the 17% interest rate in 1979.
The Bank of England reviews the economy and interest rates eight times a year (approximately every six weeks) to determine whether they need to change the Bank Rate to accommodate the current rate of inflation. Consequently, the situation will be reviewed again several times before the end of the year in a bid to prevent soaring inflation.
It’s expected that the rate of inflation will begin to fall at the beginning of 2023. The price of energy and imported goods is unlikely to increase as rapidly as it has in recent months. It’s also likely that the production difficulties that many businesses face will begin to ease. The Bank of England hopes that the rate of inflation will meet the 2% target in approximately two years.
Once inflation rates have fallen, the Bank Rate will also likely decrease, which will reduce the overall interest rates given by commercial banks.
What is the impact of rising interest rates?
The Bank Rate determines how much interest the Bank of England pays to commercial banks that hold money for it. When the Bank Rate changes, banks will change the interest rate they charge customers to borrow money or what is paid on their savings.
However, Bank Rate isn’t the only factor that influences the interest rate on borrowed money and savings accounts. Banks need to pay a lower interest rate on savings than they receive on loans to make a profit. However, they cannot offer less than 0%, otherwise, customers will likely choose another bank to deposit their money.
When the Bank Rate comes close to 0%, the rate of which banks will pass it on to savings accounts and borrowing rates will reduce. As the Bank Rate starts to rise further away from 0%, it will likely lead to a smaller rise in borrowing and saving rates.
How does the rise in interest affect me?
High-interest rates are positive for savers because most independent banks will pass on the interest rate rises. This means that you will earn a higher return on the money in your savings account. However, interest rates aren’t keeping up with rising prices for people who are putting money away.
A fixed-rate savings account means that you will probably earn higher interest on your savings than in an easy-access account. However, it also means that you may have to wait until your fixed rate deal ends before you notice the impact of rising interest rates. If you decide to fix again at the end of your current term, it might be a good idea to fix for a shorter term so that you can benefit if the interest rates rise further.
Easy-access accounts allow you to withdraw your money at any time. The interest rates for this type of account are also variable, which means that lenders may not pass on the higher interest rates. This will vary from bank to bank, but an increase isn’t guaranteed unless your savings rates track the base rate.
You won’t be directly affected by increased increase rates if you have a fixed mortgage because the rates will stay fixed for the duration of your contract. Fixed-rate mortgages usually last for two or five years or up to 10 years in some instances. This does mean that whilst you won’t notice a difference during the fixed period, the rising interest rates will impact you once it ends.
If you can afford to, it’s a good idea to start overpaying your mortgage when you are on a fixed rate, as the rates could increase further in the future. You can also compare your fixed rate mortgage to other fixes to see if it’s worth leaving early. However, you need to keep an eye out for early redemption fees as they can be very costly.
Having tracker or variable rate mortgages means that you will face higher repayments when interest rates rise. You will revert back to a variable mortgage once your fixed rate mortgage ends unless you remortgage onto another deal. The lender can decide how much they want to increase the interest on standard variable mortgages, but it’s likely that the rise will be passed on to borrowers at some point.
Why does raising interest rates help lower inflation?
Due to various factors, interest rates have risen and increased the cost of spending money. Consumers and businesses are deterred from spending or borrowing money. This means that people try to save their money instead so that they can earn some interest.
With more people saving their money and fewer people spending, demand for goods and services falls. In theory, this should have a knock-on effect and prevent the costs from rising. Companies may even reduce their prices to encourage customers to buy their products.
When people spend less on goods and services, the cost of both will rise more slowly, which will slow down the rate of inflation. The opposite is also true when interest rates are low. People tend to borrow more money when interest rates are low because it means that they have less to repay. When the rates are low on savings accounts, there is less incentive for people to save and consequently, they spend instead, which increases inflation.
The Bank of England sets the Base Rate to help influence inflation as it also influences all other interest rates in the country. The Bank of England can also buy and sell bonds (usually government) from financial markets. This process of buying assets is called quantitative easing, which also helps the Bank of England to influence interest rates on savings and loans.
How can I prepare for rising interest rates?
The best way to prepare for changing interest rates is to make a financial plan. You will likely benefit from rising interest rates if you have savings, but this won’t be the case if you have a mortgage.
A financial plan can help you work out how much you would need to pay on your mortgage based on additional interest rate increases. For example, how much you would need to pay each month if there was an increase of 0.25%, 0.5% or 0.75%. This can help you to predict how much you would have to pay each month whenever there is an interest rate rise and how much you need to budget.
If you’re worried that you wont be able to afford the raised interest rates of your mortgage deal, you can seek help from a financial advisor. They can help to assess your income and expenditure early on so that you can make the necessary changes before you reach financial difficulty.
You should find out what mortgage deal you are on to see whether you will be impacted by increasing interest rates. A fixed-rate mortgage deal, for example, would mean that an interest rate hike wouldn’t have a direct impact on you, but it would if you had a variable mortgage.
It’s advisable to look at switching your mortgage deal as your current one nears the end. You can also look at switching while you still have time left on your deal if you find a better offer, although this can be accompanied by some early redemption fees.
Summary
UK interest rates have risen to 1.75% in an attempt to combat high inflation. Factors such as the Russo-Ukrainian war and the recent Covid pandemic have increased inflation, as they have pushed up the cost of goods and services. The Bank of England is tasked with keeping inflation at 2%, which means that they have increased interest rates in an attempt to lower inflation.
One of the ways that the Bank of England can lower inflation is to increase the Basic Rate of interest, as this will impact interest rates across the country. While the biggest high street banks don’t always pass on the increased interest rates straight away, banks will pass them on to savings accounts, and borrowing rates will reduce when the Basic Rate nears 0%.
Interest rates look set to rise further in the coming months, but it is estimated that this will lower inflation to 2% in approximately two years. This is a positive for savers as they will see more return on their cash, but it means that individuals will have to repay more on their mortgages.
