Bank of England hikes rates to 3%

The Bank of England has raised interest rates yet again – the biggest hike seen in decades. Here’s what the central bank’s latest move could mean for you and your money.

The Bank of England has increased interest rates by 0.75 percentage points – taking the base rate from 2.25% to 3%.

This is the most aggressive rate hike in recent memory and comes as the central bank is trying to fight double-digit inflation in the UK. 

The Bank of England’s interest rate decision follows a similar move from the US Federal Reserve. Yesterday America’s central bank raised its key lending rate by 0.75%.  

The Fed is also aggressively trying to tame inflation in the US. But while interest rates in the country are now sitting at the highest level since the financial crisis, inflationary pressures are showing no signs of abating.  

The Fed has now increased interest rates six times in a row. On the last four occasions, the central bank has increased rates by 0.75% taking its benchmark interest rate from 0% to between 3.75% and 4%.  

The European Central Bank is also hiking rates to try and tame inflation. Last week it increased rates by 0.75%.  

Why is the Bank of England increasing interest rates? 

Benchmark central bank interest rates set the price for credit in their respective regions.  

In theory, lower interest rates encourage consumers and businesses to spend. As borrowing becomes cheaper, it’s easier for businesses to pursue growth projects and consumers to borrow to buy things like cars and houses.  

And if you’re earning nothing on your savings, what’s the point in saving money?  

As demand increases, companies can get away with putting up prices. This drives inflation.  

Higher interest rates are supposed to do the opposite. They discourage spending and borrowing. As companies fight for business as spending declines, they should lower prices. 

That’s the theory anyway.  

In practice, there’s no guarantee higher interest rates will lower inflation as inflation can be influenced by multiple outside factors.  

For example, today higher energy prices are the main reason why inflation is so high, but this is a result of the war in Ukraine. Even if the Bank of England takes interest rates to 10%,  it cannot control geopolitical factors. 

Nicholas Hyett, Investment Analyst, Wealth Club says, “The Bank of England has raised interest rates to 3%, a level not seen since 2008. This is the eighth increase in a row and the biggest single rate rise since the late 1980’s. The Bank’s inflation forecasts have also been announced which show that CPI is expected to remain high at around 11% in the near term before falling back next year, although it is expected to remain well above the Bank’s 2% target.”

The Fed, Bank of England and European Central Bank have all said they are willing to keep increasing interest rates for as long as it takes to bring inflation back to their long-term targets. That’s around 2%.  

How high will interest rates go? 

It’s unclear how high rates will have to go to meet this goal, but there’s a real chance they could move significantly higher over the coming months and years.  

In 1980, the Fed hiked rates to more than 20% in an attempt to control double-digit inflation.  

There’s no guarantee that will happen today, although we do know that over the past 50 years the benchmark interest rate in the US has averaged 5.2% and over the past 300 years, the average interest rate in the UK has been in the region of 4.5%.  

Analysts suggest rates could reach 4.75% in the UK next year, although these projections are subject to change.  

Janet Mui, head of market analysis at wealth manager RBC Brewin Dolphin notes,  “The good news is that the restoration of calm in UK markets means the BoE faces less pressure to hike aggressively. UK interest rates are expected to peak at 4.75% in late 2023, much milder than over 6.25% priced in after the mini-budget. The slump in the European benchmark natural gas prices, the energy bill support and potential austerity point to a lower inflation trajectory than previously pencilled in."

A couple of weeks ago analysts were projecting rates of up to 6%.  

What do the Bank of England’s decisions mean for you?  

This suggests consumers and businesses are going to have to get used to higher interest rates. That means higher interest rates on personal loans, credit cards, mortgages and business loans.  

Conversely, the rate of return on savings accounts is now better than it has been at any point in the past decade. Annuity rates have also returned to levels not seen since the beginning of the financial crisis, great news for those who want to buy a guaranteed stream of income in retirement.  

So, savers are set to benefit as interest rates increase. Unfortunately, life is also going to get harder for borrowers.  

Laura Suter, head of personal finance at AJ Bell, says, "The chunky hike in rates today is another boost to savers who are finally getting higher interest rates on their savings. Back in December, before the Bank started raising rates, the top easy-access account was paying 0.65%, but that has now leapt to 2.81%."

"But the 1.6 million people on a tracker or variable rate will see costs increase. For someone with £250,000 of borrowing, a 0.75% rise means an extra £100 a month in costs. At £400,000 of borrowing that rises to an extra £160 a month or more than £1,900 a year."

But there could be a silver lining in all of this.  

The cost of credit is starting to weigh on the UK housing market. House prices are already starting to tick lower in the face of 6%+ mortgage rates. However, while house prices are coming under pressure, wages are growing. Average wage growth across the country exceeds 5%, rising to 10% in some sectors.  

Falling house prices and rising wages suggest property could become more affordable, even if the cost of borrowing is rising.

Remember to get your tickets for the MoneyWeek Wealth Summit hosted by Merryn Somerset Webb, on 25 November 2022! – we’ve got some brilliant speakers lined up and, given everything that’s going on, we’ll have an awful lot to talk about.

Book your place now at moneyweekwealthsummit.co.uk

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