Interest rates are increasing in a bid to reduce inflation
The Bank of England has just confirmed that it will be increasing interest rates by 1.75%.
This is the biggest single increase since 1995 and has taken interest rates to their highest level since December 2008 just after the financial crash.
As inflation soars to a 40-year-high at 9.4%, prices reach staggering levels and the cost of living crisis hits people across the country, here’s how what this new announcement means and how it will affect you.
What is interest?
An interest rate is the amount it costs to borrow money.
These rates in the UK used to be much higher, but the financial crash meant they were slashed to reduce the fall-out. They’ve been at historically low levels since, and only last year, they dropped to 0.1%.
This number has stayed low for the last 13 years, and only now has it crept up to late 2008 levels.
As inflation is the rate at which prices rise, interest rates are used to balance it out and reduce soaring prices.
Essentially, if it costs more to borrow money, people are less likely to lend it, which should steady out the sudden changes in the economy.
Interest rates are decided by the Monetary Policy Committee, a team of nine economists. The last increase occurred only in June, when the rates climbed from 1% to 1.25% – yet another noteworthy increase.
Why is this increase in interest so significant?
This is the sixth time in a row the Bank of England has increased interest rates.
Before the announcement, interest rates were at 1.25%.
This 0.5% increase is the largest single jump in interest rates for more than 27 years – and they might be raised to even higher levels soon.
Capital Economics analysts, for example, think the Bank of England has not gone far enough to tackle inflation with this increase, and that rates will have to go to 3% before inflation is truly tackled.
OK – so what does this have to do with inflation?
Rising prices is also known as inflation.
By rising interest rates, the cost of borrowing is increased, meaning people are encourage to spend less.
The Bank of England hopes to slow the rate of inflation by increasing the interest rate, especially after its early forecasts suggest it could surpass 13% later this year as businesses continue raising prices in order to make a profit.
It also claimed that inflation will still be above 9% in a year’s time.
The bank wants to slow this alarming inflation rate, but not stop economic growth altogether by stopping spending completely.
What does this mean for my expenses?
Around three quarters of mortgages are fixed, meaning the payment is consistently the same and so will not be impacted – for now.
The remaining households with mortgages will see their monthly repayments increase. The increase means those on typical tracker mortgages will have to pay £52 extra per month (this is a total increase of around £167 compared to before December 2021).
Those on standard variable rate mortgages will see a £59 increase, meaning they have to pay around £132 more compared to December 2021.
Credit cards, bank loans and car loans will be impacted, too – and lenders could increase fees on that now interest rates have risen.
Even savings could be affected. Individual banks pass on the interest rate rises usually, so savers get more return back – but, for people putting money away now, these interest rates do not keep up with rising prices.
The Bank of England also predicted that dual fuel energy bills on average will reach £3,500 – which is just shy of the £300 a month by the time the winter rolls around.
Does this mean a recession is more likely?
The Bank of England has predicted a recession starting this year, which could last as long as the 2008 financial crisis, which was five quarters.
Increasing borrowing costs does mean the UK is more likely to fall into a recession (a term used when there’s negative growth within the economy for two quarters of a year).
But, the governor of the Bank of England, Andrew Bailey, vowed last month that it still planned to stick to its 2% inflation target – and interest rates is the best way to that.
He said: “There are no ifs or buts in our commitment to the 2% inflation target. That’s our job, and that’s what we will do.”
There’s also only so much the Bank of England can do, as the UK is also impacted by prices around the world. For instance, energy bills soared here when Russia recently reduced its natural gas supply to mainland Europe, because the worldwide supplies were squeezed.
Prices are going up quickly all over the world too, now that Covid restrictions have eased – however, there are not enough goods to go around, so the reduced supplies again mean prices rise.
Other countries are also trying to tackle inflation right now – the US central bank has increased its rates significantly in recent months, up to 2.25% to 2.5%.
The European Central Bank has increased rates for the first time in more than11 years.
The BBC’s Faisal Islam also pointed out that if the Bank’s predictions are correct, the whole economic landscape will change for the next prime minister.
If correct these predictions would upend the fiscal numbers upon which the entire prime ministerial debate has been had, easily wiping out (probably multiples of) the £30bn fiscal headroom
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