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Bank of England widely expected to raise interest rates to 3.5%

Governor of the Bank of England Andrew Bailey
Markets estimate the Bank of England will increase interest rates on Thursday by 50 basis points to 3.5%. Above, the Bank governor Andrew Bailey. Photo: Justin Tallis/AP

The days of cheap mortgage rates appear to be over for homebuyers, as markets expect interest rates to climb by 0.5 percentage points when the Bank of England (BoE) meets on Thursday.

According to a Reuters poll, financial markets have priced in a 78% chance that Threadneedle Street will raise rates to 3.5%, and a 22% chance of a rise to 3.75%.

The survey of 54 economists found that most expect a 50 basis point increase, with only two expecting a larger 75bp hike.

"To our minds, another 50 basis point increase looks likely," Investec economist Philip Shaw said. "The BoE has made it pretty clear that inflation is too high. It's concerned about the tightness of the labour market. And there are big risks to its projections."

The Bank of England has hinted time and time again that it is preparing to further raise interest rates over concerns that inflation could become embedded in the UK’s economy. Britain is also facing a recession next year.

Read more: Interest rates: Record rise in 30-year mortgages for first-time buyers

Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, said: “Inflation fears are expected to trump recession dread at the Bank of England next week.

"It’s going to make life more difficult if your borrowing is linked to the base rate, but the impact on fixed rate mortgages and savings is more complicated. We may well see the weird phenomenon of base rates going up while savings and mortgage rates drop,”

UK inflation eased to 10.7% in the year to November, down from a 41-year high of 11.1% in October.

Falling motor fuel prices led the decline in the core consumer prices index (CPI) measure of inflation, however, the price of food and non-alcoholic drinks went up by 16.5%.

Although inflation cooled last month, it is still five times over the BoE’s mandate target of 2%.

Watch: What is a recession and how do we spot one?

“Taming inflation is proving to be harder than expected as price pressures broaden and become more entrenched. Central bankers are having to take the gloves off. That won’t be good for growth,” said Brian Coulton, chief economist at Fitch.

The ratings agency now sees interest rates rising even further next year.

“Our latest 4.75% peak forecast for the BoE has been revised up by 150bp since the previous GEO. We do not anticipate a pivot to rate cuts until 2024,” it said.

In the last Bank’s Monetary Policy Meeting (MPC), it raised interest rates to 3% with the biggest single rise in borrowing costs since 1989.

The Bank of England has raised interest rates to 3% (Yahoo News UK/Flourish)
The Bank of England has raised interest rates to 3% (Yahoo News UK/Flourish)

At the time, the Bank’s chief economist set the scene for the 15 December meeting.

“I think there is more to do. We’ve done some, that’s what we did last week. And there’s still more to do,” Huw Pill said.

However, two policymakers who voted against November's three-quarter-point rise – the BoE's biggest rate hike in over 30 years – have warned that much more tightening would lead to an unnecessarily severe recession.

BoE rate-setter Swati Dhingra said in a recent interview that higher interest rates could lead to a deeper and longer recession, adding there were few signs demands for higher wages risked a wage-price spiral.

Read more: UK finalises plan to regulate crypto

For homeowners on tracker mortgages or a standard variable rate, the pain is going to be immediate.

Coles said that there is “every chance” the ranks of these homeowners have been swelled in recent months, as borrowers reached the end of their fixed rate deal and decided to let it roll over onto the SVR while they waited for fixed rates to come down.

At this stage, Moneyfacts says the average SVR is 6.4%, so if the full rise is passed on, rates will be edging close to 7%. “It’s going to make life incredibly difficult for those who rolled over from a deal at 2% or 3%, and may encourage them back into the certainty of a fixed rate deal again,” Coles warned.

Those looking for a fixed rate mortgage might be better off as the 0.5 percentage point rise could already be priced in.

“So instead of encouraging rate hikes, those fixed rate deals are likely to continue on their current downwards trajectory,” Coles said.

Moneyfacts says that both the two-year and five-year fixed rate average have fallen below 6%, and the best deals are offering around 5%.

Read more: Cost of living payments should be spread out over winter, say MPs

The rise in interest rates has one upside, as it boosts the potential for better annuity rates.

Helen Morrissey, senior pensions and retirement analyst at Hargreaves Lansdown, said: “The prospect of another rate increase could spell good news for an annuity market that has risen rapidly over the course of the year. While incomes have declined from the dizzy heights achieved in the immediate aftermath of the mini-budget they remain the highest seen in over a decade."

“Data from our annuity comparison tool shows that at the time of writing a 65-year-old with a £100,000 pension could get themselves an income of £7,039 a year – a huge improvement on the £5,131 they could have got at the same point last year.

"Annuity incomes are determined by the yields on long-term gilts and interest rates have an effect – we cannot guarantee an interest rate increase will further boost incomes in the coming weeks, but it is a distinct possibility,” she added.

Experts expect the BoE to ease up on the base rate only in the second quarter of 2024.

The move on Thursday will also affect the pound against the dollar.

Matthew Ryan, head of market strategy at global financial services firm Ebury, said: “In the event of a 50bp rate hike, and an increasingly divided committee, we think that sterling could sell-off, particularly should the statement or meeting minutes once again push back against current market pricing for UK interest rates.

"That said, another 75bp hike cannot be ruled out entirely. This would be bullish for GBP, given current market pricing.”

Watch: How does inflation affect interest rates?