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Bank of England raises interest rates to 3.5% in blow to mortgage owners

  • Interest rates were raised by 0.50 percentage points to 3.5%

  • Higher borrowing costs will hit homeowners as mortgages will climb

  • Interest rates are the tools that central banks use to keep inflation, i.e. rising prices, under control

  • Read the full article to see what was behind the Bank of England's decision

Interest rates: Governor of the Bank of England Andrew Bailey
Governor of the Bank of England Andrew Bailey. The Bank's Monetary Policy Committee hiked interest rates yet again on Thursday. Photo: PA/Alamy (LEON NEAL / AFP)

The Bank of England (BoE) has raised the UK interest rates by 50 basis points to 3.5%, the highest level since October 2008.

Six members of the monetary policy committee – governor Andrew Bailey, Ben Broadbent, Jon Cunliffe, Jonathan Haskel, chief economist Huw Pill and Dave Ramsden, voted in favour of a half-point rate hike.

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But three members voted against. Swati Dhingra and Silvana Tenreyro preferred to maintain Bank Rate at 3%. Hawk Catherine L Mann preferred to increase Bank Rate by 0.75 percentage points, to 3.75%.

Interest rates have hit 3.5%
Interest rates have hit 3.5%

Raising interest rates increases the cost of borrowing for households and businesses in a strategy designed to tackle double-digit inflation.

The rate of inflation eased to 10.7% from 11.1% last month, falling back October’s 41-year high of 11.1%, the Office for National Statistics said.

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

The cost of living in the UK continues to soar (Yahoo News UK/Flourish)
The cost of living in the UK continues to soar (Yahoo News UK/Flourish)

Read more: Average house price rises by £33k as costs start climbing again

Certain borrowers will face immediate rises in their payments as the Bank maintains its pressure on inflation.

Sarah Coles, senior personal finance analyst at Hargreaves Lansdown, said: "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.”

Marc von Grundherr, director of Benham and Reeves, added: “There’s certainly no cold snap on the cards where interest rates are concerned with yet another substantial increase pushing the base rate to a 14 year high.

"This will be as welcomed by homeowners as the proverbial lump of coal on Christmas morning, with those on variable rate products now facing yet another immediate increase in their monthly mortgage payments.

"With many households struggling to heat their homes in these arctic conditions, this will be the last thing they need in the run up to Christmas.”

What rate rise means for personal finance and mortgages

Alice Haine, personal finance analyst at Bestinvest, warned that UK households face even more financial pressure.

“Increasing interest rates when the economy is on the brink of a recession might not be typical behaviour for a central bank, but the Bank of England is intent on taming double-digit inflation and bringing it closer to its target of 2%. Inflation may have passed its peak after dropping to 10.7% in the 12 months to November from a 41-year high of 11.1% in October – with the BoE expecting it to fall rapidly over the first quarter of 2023," she said.

“Higher interest rates will certainly add more pressure on household finances, particularly for borrowers whose finances have already been hammered by the toxic mix of rising prices, falling real incomes, soaring borrowing costs and tax rises next April. But interest rates are widely expected to peak at about 4.5% next year – with rates potentially falling from there as the lender looks to support the economy through the recession.

“For now, with inflation still high at 10.7% and households trying to absorb the sharp rise in interest rates from 0.1% at the start of December last year to 3.5% now – the personal finance misery is far from over, particularly when you consider the damage a contracting economy, rising unemployment and falling property prices can have.

“For younger generations who have only borrowed money during the era of ultra-low rates, an interest rate of 3.5% can seem terrifying, but for those more accustomed to higher interest payments, the expected peak in rates simply takes them back to the bottom end of where rates used to be before the financial crisis of 2008.

Those on tracker or standard variable rate (SVR) mortgage deals will feel the most immediate pain.

Moneyfacts said a Bank rate rise of 0.5 percentage points on the current average SVR of 6.40% would add approximately £1,509 onto total repayments over two years.

Hunt to 'stick to plan' amid recession fears

Chancellor Jeremy Hunt admitted this was "tough for people" but that inflation needs to return to around 2%.

"High inflation, exacerbated by Putin's war in Ukraine, continues to plague countries across the world, eating into people's pay cheques and driving up food and energy prices," he said.

"I know this is tough for people right now, but it is vital that we stick to our plan, working in lockstep with the Bank of England as they take action to return inflation to target.

"The sooner we grip inflation the better. Any action which risks permanently embedding high prices into our economy will only prolong the pain for everyone, stunting any prospect of economic recovery," he added.

The BoE has already raised rates at every meeting this year, in a tightening cycle that began last December. After November’s meeting, the Bank hinted that interest rates wouldn’t rise as high as the markets had been pricing in.

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.

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.

The Bank of England has said it now expects UK GDP to decline by 0.1% in the final quarter of 2022, which is 0.2 percentage points stronger than expected in last month’s report but would still show the UK entering a technical recession.

It added that household consumption has remained “weak” and it has seen the housing market “continue to soften”.

Watch: How does inflation affect interest rates?

Read more: UK inflation eases to 10.7% but food prices continue to soar

A majority of the central bank's nine monetary policy-makers believe further interest rate rises may be needed at future meetings, to bring inflation down towards its 2% target.

"The majority of the Committee judges that, should the economy evolve broadly in line with the November Monetary Policy Report projections, further increases in Bank Rate may be required for a sustainable return of inflation to target," the minutes of the MPC meeting said.

Threadneedle Street's announcement comes after the Federal Reserve slowed the pace of its rate rises last night but signalled US interest rates would go higher than expected, fanning fears a recession is on the way.

The Bank of England will hold its next interest rate-setting meeting on 2 February 2023.

Watch: Will UK house prices ever fall?