Bank of England raises interest rate to 4%

The Bank of England raised rates by 0.5%, marking the base rate’s 10th consecutive increase.

The Wellington statue and the Bank of England
(Image credit: © Getty images)

The Bank of England (BoE) has raised its base rate by 0.5% to 4% – the highest level since 2008.

The rate hike - the 10th consecutive increase - was widely expected as the BoE continues to wrestle with double-digit inflation.

James McManus, chief investment officer at Nutmeg, comments, "“This is the tenth consecutive increase in the Bank of England’s base rate, which shows how determined policymakers have been to ‘normalise’ monetary policy. The base rate was cut to a historic low of 0.1% in March 2020 as the Covid pandemic wreaked havoc on the economy, and since then the only way has been up. That’s not necessarily a bad thing for the economy, as keeping interest rates close to zero can have unintended consequences in areas from inflation to house prices and debt levels."

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The rate of CPI inflation slowed for the second month in a row to 10.5% in December but remains miles away from the BoE’s 2% target.

Rising food prices and higher energy costs are the primary drivers behind inflation, even though the government has tried to curtail energy costs with the Energy Price Guarantee.

The BoE has admitted rate rises could help push the economy into a recession, but it can’t afford to slow down just yet with inflation remaining in the double digits.

However, on the other side of the pond, the US Federal Reserve has slowed its pace of rate hikes.

Yesterday the central bank increased its base rate by a quarter of a percentage point after a 0.5% increase in December following the latest inflation data from the US, which showed a slowdown in inflation.

We’ll be updating this page throughout the day with all the latest news and comment on the Bank of England’s latest move, so stay tuned.

Why is the Bank of England increasing interest rates?

Even though the rate of CPI inflation slowed to 10.5% in December from a peak of 11.1% in November, it’s still far too high.

In theory, by increasing the cost of money consumers will be encouraged to save, and less inclined to spend – indeed, customers are already benefiting from some of the best rates on savings accounts in years.

If people reduce their spending, businesses are left to compete for the remaining customers, usually by reducing prices.

But this doesn’t always work out in practice, especially when inflation is being driven by factors the BoE cannot control, such as rising energy and food prices due to Russia’s invasion of Ukraine last year.

Analytics group Kantar showed grocery price inflation hit a record 16.7% in the four weeks to January 2023.

Energy prices look unlikely to come down in 2023, and now the RAC has warned petrol prices look likely to rise.

It looks as if these inflationary pressures will be with us for some time.

How much further will interest rates rise?

While it looks as if inflation has peaked, as noted above, there are still plenty of reasons to believe prices will continue rising.

That makes it much harder to say for sure when the BoE will stop hiking.

As the Fed noted yesterday when it published its interest rate decision, “ongoing increases” might be needed to continue lowering the rate of inflation.

As such, it looks as if both central banks might continue to increase rates further in the months to come.

Still, it seems unlikely rates will hit the levels predicted last year.

Following the chaos brought on by the mini-Budget, markets were predicting rates could peak at 6%.

However, they are now forecast to rise to 4.5% and remain there throughout 2023, although these are just projections.

The BoE knows further rate rises will continue to slow the economy – GDP shrank by 0.3% in the three months to November 2022. The IMF has said it expects the UK to be the only G7 economy to contract this year after it revised updates. The MPC is likely to take all of this into account going forward.

The good news is that the BoE's new economic forecasts are far more optimistic than they were.��

As David Goebel, Investment Strategist at wealth manager Evelyn Partners says, "Better than expected data in terms of GDP (0.1% for November, relative to expectations of -0.2%), and strong wage growth led the Bank to improve its growth expectations for 2023 to -0.5% from their previous estimate of -1.5% in November. This upgrade has led to a significant reduction in the forecast depth and length of recession facing the UK, with the economy now set to contract by almost 1% over five quarters, rather than 2.9% over eight quarters."

What do rising interest rates mean for you?

Higher interest rates increase the cost of borrowing. The impact they have had on the property market is clear – mortgage borrowing fell by £1bn in December as buyers retreated from the market due to higher mortgage rates.

Nationwide reported UK house prices fell for the fifth consecutive month in January, as growth slowed to 1.1% from 2.8% in December.

Simon Gammon, Managing Partner at Knight Frank Finance, notes, "Fixed rate mortgages are now as cheap as they are going to be for some time, or at the very least are close to bottoming out.

"Before Thursday's decision, the best five year fixed products could be found as low as 4.19%, while the best trackers sat at around 3.94%," Gammon adds. That's compared to around 2% a year ago.

Knight Frank believes house prices could fall by as much as 10% as buyers and sellers get used to the "new normal" for mortgage rates.

It's not just mortgages that are getting more expensive. All forms of borrowing are becoming more costly, from credit cards to personal loans and business loans. Every business and consumer that uses borrowing to support themselves is going to have to deal with higher credit costs.

And savers have enjoyed some of the best rates they have seen in years - the best regular savings accounts are offering rates of up to 7% - real interest rates (after inflation) are still negative, meaning savers' purchasing power is declining.

This combination of inflation, low real interest rates and high borrowing costs is a toxic combination for businesses and consumers.

George Lagarias, Chief Economist at Mazars comments, “Persistent inflation and higher rates which have begun to translate into much higher mortgage payments will continue to eat into real disposable incomes in the coming months."

"We believe that until inflation is materially down, the next few months could be some of the most difficult for consumers in recent years," Lagarias adds.

It's going to continue to be tough for investors and savers as well. To prevent inflation from eroding their purchasing power, savers need to shop around for the best deals, while investors need to carefully review their current holdings.

As Les Cameron, savings expert at M&G Wealth notes, "“As savings rates begin to creep up, people should shop around to secure competitive rates for their cash savings. The fundamental issue remains though, interest rates are substantially lower than inflation so getting a better rate for your cash or a better than cash return on investments will help stem the erosion of value of your money, and will help to ensure your finances are more resilient against future challenges.”

Nicole García Mérida

Nic studied for a BA in journalism at Cardiff University, and has an MA in magazine journalism from City University. She joined MoneyWeek in 2019.