Bank of England raises interest rate by 0.5%

The Bank of England has raised interest rates once again, this time by 0.5%. This takes the bank’s base rate to 3.5%, the highest it’s been since 2008.

Bank of England
(Image credit: © Scott Barbour/Getty Images)

The Bank of England has raised interest rates by 0.5%, which means the central bank’s base rate now stands at 3.5%, the highest level since October 2008.

This is the ninth consecutive increase in the base rate. Last month the bank’s Monetary Policy Committee (MPC), which sets interest rates, decided to raise rates by 0.75%, one of the steepest hikes of the last few decades as inflation surged.

The central bank has been hiking rates to try and control inflation, but policymakers are now worried that hiking rates too far too fast will hurt the economy and they’re starting to take their foot off the pedal.

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A month ago analysts were expecting the MPC to hike rates by 0.75% at its December meeting. The slower pace of growth comes as UK GDP shrank by 0.3% in the three months to October and the chancellor warned we are in a recession.

Other central banks are also scaling back their fight against rising prices.

Yesterday the US Federal Reserve announced a rate hike of 0.5%, taking the base rate in the US to 4.5% its highest in 15 years. However, it also said it would be slowing down on its rate increases to see how the economy was responding.

And the European Central Bank has also slowed the pace of hiking. After the BoE announcement, it raised interest rates by 0.5% after a 0.75% jump at its last meeting.

All three banks remain committed to taming inflation while trying to minimise the collateral damage to their economies.

Why did the Bank of England increase interest rates?

While the headline inflation figure fell to 10.7% from 11.1% in November, UK inflation is still running at over five times the BoE’s 2% target.

Higher interest rates increase the cost of borrowing, In theory, this should put people off spending and encourage them to save decreasing demand. Businesses then have to compete for the remaining business usually by cutting prices.

That said, the BoE has admitted its aggressive stance against inflation might be hurting the economy by increasing costs for borrowers and reducing spending.

Additionally, inflation is being driven by factors outside of the BoE’s control.

Food and energy prices have shot up this year largely due to Russia’s invasion of Ukraine, which the central bank cannot control.

How much further will interest rates rise?

This month’s inflation figures would suggest inflation has peaked, and that could mean interest rates won’t rise much higher.

It certainly seems as if that’s the case in the US. After announcing a 0.5% rate hike yesterday, Jerome Powell, the Fed’s chairman, said that though there was still “some way to go” to control inflation, the bank wanted to slow down the pace of rate hikes to see how the economy was responding.

Back in the UK, a couple of months ago analysts were forecasting peak interest rates of nearly 6%, but now it seems they don’t expect the BoE to go much further than 4.25%.

“With fractionally moderating inflation, the looming threat of recession and a slight tick up this week in the unemployment rate, the Bank of England rightfully voted for a more cautious approach to tightening," noted Victoria Scholar, head of investment at interactive investor.

“The Bank of England can feel justified by its counterparts stateside that it made the right decision. Both the BoE and the Fed adopted the same approach, voting for a more dovish 50 basis point hike, having both raised rates by 75 basis points at their previous meetings," Scholar went on to add.

The minutes of the MPC meeting, released after the rate decision, showed that the bank's outlook for the economy is starting to pick up, albeit modestly.

"There was much to like within the minutes," noted Nicholas Hyett, an Investment Analyst at Wealth Club.

"The rising value of sterling is good for our buying power as a nation – taking some of the edge off international inflation. This, together with historic price rises rolling out of the data, mean headline inflation will fall substantially next year," Hyett added.

"That should help ease demands for wage increases, reducing the chances current inflation becomes endemic. Further good news came in the form of easing global supply pressures."

What do rising interest rates mean for you?

Rising interest rates mean higher borrowing costs. This is the case for all debt – loans, credit cards, and mortgages.

Mortgage rates have fallen from their peak of 6.65% in October, but they remain high compared to recent standards. According to Moneyfacts the best two-year fixed-rate mortgage now costs 4.7% compared to 2% this time last year.

Rising rates are particularly bad news for those whose fixed rates end in 2023 – UK Finance estimates this is the case for around 1.8 million homeowners.

As Alice Guy, Personal Finance Editor at interactive investor explained, "rates rises mean someone with a £200,000 tracker mortgage could be paying an extra £326 per month which is an eye-watering annual increase of £3,912."

The effect of rising rates, coupled with the rising cost of living, has already begun to affect the property market and prices are creeping down after two years of fast growth.

Rising rates are also good news for savers. Providers are not obligated to raise rates in line with inflation, and currently, there are no deals out there that come close to helping savers earn a real return on their money.

Still, higher interest rates have been trickling down to the best regular savings accounts, so it could be a good time to look for a better home for your savings.

“Higher interest rates do not always translate to higher savings rates. It could take months for the increase in interest rates to trickle through to savers – if at all. The acceleration in the frequency of rate rises has meant that some savings providers may still be catching up to past base rate rises. Put simply, you may get a better savings rate in the near future – but there are no guarantees. The amount you are looking to save could guide your decision. An uptick in savings rates could mean the difference between pennies and hundreds of pounds depending on how much you have to save," noted Myron Jobson, Senior Personal Finance analyst at interactive investor.

They have also had a positive impact on annuity rates. Rates have hit a 14-year high, breathing life back into a product that for years has been overlooked.

Rupert Hargreaves

Rupert is the former Deputy Digital Editor of MoneyWeek. He's an active investor and has always been fascinated by the world of business and investing. 

His style has been heavily influenced by US investors Warren Buffett and Philip Carret. He is always looking for high-quality growth opportunities trading at a reasonable price, preferring cash generative businesses with strong balance sheets over blue-sky growth stocks. 

Rupert has freelanced as a financial journalist for 10 years, writing for several UK and international publications aimed at a range of readers, from the first timer to experienced high net wealth individuals and fund managers. During this time he had developed a deep understanding of the financial markets and the factors that influence them. 

He has written for the Motley Fool, Gurufocus and ValueWalk among others. Rupert has also founded and managed several businesses, including New York-based hedge fund newsletter, Hidden Value Stocks, written over 20 ebooks and appeared as an expert commentator on the BBC World Service. 

He has achieved the CFA UK Certificate in Investment Management, Chartered Institute for Securities & Investment Investment Advice Diploma and Chartered Institute for Securities & Investment Private Client Investment Advice & Management (PCIAM) qualification.