Base Instinct: What the New Bank of England Base Rates Mean for You

In a bid to offset the upcoming rises in the cost of living, the Bank of England has increased interest rates for the third time in four months.

These rates (which have gone from 0.5% to 0.75%) were last seen in March 2020, when a certain virus sent us all into lockdown and our economy into a tailspin. 

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In line with this, the Bank of England has warned that inflation (the rate at which prices rise), could tip over 8% in the near future. It has even been warned that inflation could hit double-digits in 2022, if the energy price cap is pushed up by energy prices.

What is the base rate?

The base rate is set by the Monetary Policy Committee (MPC). It’s part of the Monetary Policy action the Bank of England takes “to meet the target that the government sets us to keep inflation low and stable”.

The interest rates the Bank of England pays to the commercial banks that hold money with it are determined by the base rate. So in turn, it has an effect on the rates those banks charge us to borrow and give us when we save money.

How is the economy affected by the base rate?

How much people spend is directly affected by any change in base rates. And how much people spend influences how much things cost. So prices and inflation are affected by the base rate.

Higher interest rates tend to reduce spending. So, to meet its inflation target, the Bank of England needs to judge how much people might save and spend given the current interest rates. For example, if people don’t spend enough, businesses have less custom and make less money, and people lose their jobs. 

As a recent example, during the 2008 financial crisis, people reduced their spending and many lost their jobs. In response, the Bank of England had to cut interest rates to very low levels to support spending and jobs.  It says: “Over the past few years, our economy has needed interest rates to stay very low.” …until recently. 

Why is the cost of living going up?

Food and energy costs are sharply on the rise, and it is thought that the war in Ukraine will only make this worse (although, it’s important to remember that the war in Ukraine is not the only factor driving costs up). 

In January, prices had already increased by 5.5% – which may not sound like a lot, until you consider that it represented the fastest rate for 30 years, and the Bank of England’s target was 2%.

At the time, the Office for National Statistics (ONS) said the rising cost of living could be attributed in part to rising energy and fuel prices, which have since shot up far further. 

This latest rate rise has been attached to the rising cost of living and strong employment, according to the Bank of England. 

Will the interest rate rise affect you?

UK Finance said around two million households will see an immediate increase in their mortgage payments as a result of the rise in rates.  

Roughly £26 a month will be added to the cost of a typical tracker mortgage, the cost of a typical standard variable rate mortgage will go up by around £16 a month. If you are worried about your mortgage repayments changing, book a call to discuss your options with our mortgage advisors today.

If rates rise and you have a loan or mortgage, your interest payments may get more expensive. And if you have savings, you may be paid more interest. When interest rates rise, it’s more expensive for households and businesses to increase the amount they borrow, but in better news, it’s more rewarding to save. 

Higher rates also tend to decrease the value of wealth, in terms of people’s pensions or housing, compared to what they would have been. 

How high could interest rates go?

The Monetary Policy Committee (MPC) said more interest rate rises “might be appropriate in coming months, but there were risks on both sides of that judgement depending on how medium-term prospects evolved.”

It added: “The economy had recently been subject to a succession of very large shocks. Russia’s invasion of Ukraine was another such shock.”

In slightly brighter news, the bank said it expects inflation to “fall back materially” when prices stop going up and the impact of inflation on household incomes kicks in. 

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