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Interest rates hiked to fresh 33-year high by Bank of England

  • Interest rates were raised by 0.75 percentage points to 3% - the biggest rise since 1989

  • This is the bank rate though, the actual interest rates that banks apply varies and will be higher — expect mortgage rates to go up by more than £800 a year

  • Interest rates are the tools that central banks use to keep inflation, i.e. rising prices, under control — and current inflation is 10.1%

  • Read the full article to see what was behind the Bank of England's decision and how it could impact you

interest rates Governor of the Bank of England, Andrew Bailey, during the Bank of England's financial stability report press conference, at the Bank of England, London. Picture date: Thursday August 4, 2022.
Governor of the Bank of England, Andrew Bailey, warned of a 'tough road ahead'. Photo: PA

The Bank of England (BoE) has raised the UK interest rates by 75 basis points to 3%, its biggest hike in 33 years.

The hike will push up mortgage bills for millions of people in the coming months.

The Monetary Policy Committee (MPC) voted 7-2 in favour of lifting rates by 75 basis points. That will likely be considered a dovish outcome.

Governor Andrew Bailey defended the sharp rise in interest rates, saying: "If we do not act forcefully now, it will be worse later on."

He added that "it's a tough road ahead", pointing to the sharp rise in energy prices as a result of Russia's invasion of Ukraine.

Bailey admitted that recent interest rate rises are "big changes" that affect people's lives.

The Bank stressed the peak in rates would likely be "lower than price into financial markets".

Announcing today’s rate hike, the BoE said: "Inflation is too high. It is well above our 2% target.

"High energy, food and other bills are hitting people hard. If high inflation continues, it will hurt everybody. Low and stable inflation helps people plan for the future.

"Raising interest rates is the best way we have to bring inflation down. We know that many people are facing higher borrowing costs. In particular, many households face higher mortgage rates. And some businesses face higher loan rates. It’s our job to make sure that inflation returns to our 2% target.

"This month we have raised our interest rate to 3%. In total, since December 2021, we have increased our interest rate from 0.1% to 3%.What will happen to interest rates will depend on what happens in the economy. At the moment, we expect inflation to fall sharply from the middle of next year."

The Bank is determined to tighten monetary policy after seeing consumer price inflation hit a 40-year high of 10.1% in September, five times higher than its 2% target, driven by soaring food prices as well as the energy crunch.

It also warned that the UK could be facing the longest period of recession since reliable records began.

The economy could fall into eight consecutive quarters of negative growth if current market expectations prove correct. It would be the longest period of uninterrupted decline that the nation has experienced for around a century.

However, it would be a milder recession than in previous times.

From its highest to lowest point, gross domestic product (GDP) is expected to drop 2.9%, a much smaller decrease than the 6.3% drop seen during the 2008 financial crisis.

Read more: Interest rates: What the Bank of England's biggest hike in 33 years means for you

The Bank also predicted inflation would peak at around 11% at the end of this year, while the unemployment rate could hit 6.4% by the end of 2025.

The 0.75-point increase takes the Bank's interest rate back to levels last reached in November 2008 — and drive up costs for millions of mortgage borrowers.

It also marks the Bank’s eighth consecutive rate rise, and its largest since 1989, if we exclude the efforts to protect the pound on Black Wednesday in 1992.

The MPC has been battling runaway inflation this year with the aim to bring it back down to its 2% target. It has raised interest rates from record lows of 0.1% during the COVID pandemic to the current 3% rate.

The cost of living is soaring in the UK (Yahoo News UK/Flourish)
The cost of living is soaring in the UK (Yahoo News UK/Flourish)

Through these rate hikes, the Bank of England is trying to bring core inflation under control, which excludes more volatile elements such as petrol and energy prices.

The Bank of England “seems to be acutely aware of the dangers of over-tightening, and we think it may tolerate higher inflation as the lesser of two evils as we enter a recession,” analysts at HSBC wrote in a note to clients. “With that, the probability that hikes end in 2022 is increasing once again.”

Inflation is expected to peak at 11% in the current quarter, the Bank warned, up from 10.1% in September.

The BoE has said further interest rate hikes could be required to tame runaway inflation. But the peak rate will be lower than that which financial markets currently expect, the Bank said.

Responding to the interest rate rise, chancellor Jeremy Hunt said: “Inflation is the enemy and is weighing heavily on families, pensioners and businesses across the country.

“That is why this government’s number one priority is to grip inflation, and today the Bank has taken action in line with their objective to return inflation to target.

“Interest rates are rising across the world as countries manage rising prices largely driven by the COVID-19 pandemic and Putin’s invasion of Ukraine.

“The most important thing the British government can do right now is to restore stability, sort out our public finances, and get debt falling so that interest rate rises are kept as low as possible.

“Sound money and a stable economy are the best ways to deliver lower mortgage rates, more jobs and long-term growth.

“However, there are no easy options and we will need to take difficult decisions on tax and spending to get there.”

The hike adds even more pressure to homeowners amid ballooning mortgage costs. UK Finance said that there are more than 1.5 million households on tracker and variable rate mortgages, with the average bill expected to rise by more than £800 a year.

Mortgage rates are set to soar as the Bank of England raises interest rates (Yahoo News UK/Datawrapper)
Mortgage rates are set to soar as the Bank of England raises interest rates Chart: Yahoo News UK/Datawrapper

Karen Noye, mortgage expert at Quilter, said: "Borrowers who are on their lender’s standard variable (SVR) rate may see a significant jump. A good rule of thumb is that a lender’s SVR is around 2-5% higher than the Bank of England’s base rate. Therefore, now the Bank of England has raised the base rate to 3% in the best case scenario someone will be paying around 5% interest on their mortgage and potentially up to 8%, if on an SVR.

"Let’s assume that yesterday when the base rate was 2.25% someone on their lender’s SVR was paying 4.25% interest on a £200,000 mortgage over 25 years then they would have been paying about £1,083 per month. Now the base rate has climbed to 3%, the SVR will also climb to a conservative estimate of 5%. That same mortgage at that interest rate would cost £1,169. A difference of around £86 a month."

Read more: Inflation: Milk, tea bags and sugar prices soar as food bills hit record highs

On Wednesday, the US Federal Reserve raised rates by three-quarters of a percent and signalled that more increases were to come.

Last week, the European Central Bank raised interest rates by 75 basis points, as expected, taking the deposit rate to 1.5%, and signalled further rate hikes in the months to come.

The pound (GBPUSD=X) extended its losses after two MPC members voted for a more dovish 50 basis-point increase in rates.

Naeem Aslam, chief market analyst at AvaTrade, said: "The pound has lost more momentum on the back of the BoE’s decision. A typical text book trade is out of the window because currencies usually move higher when a central bank increases rates.

"In the UK, it is mainly about fear of recession and the fact that the BoE sees recession prolonging for two years; it means tough times are ahead, and we are going to see the economy, markets, and the currency tanking in the coming months."

Watch: How does inflation affect interest rates?