The base rate has been held at 5.25% since August 2023. Falling inflation had raised hopes that the Bank of England may look to starting cutting the cost of borrowing as early as March. But will a surprise slight rise in inflation in December dampen those hopes?
Inflation has fallen significantly through 2023. With wage growth slowing more than expected and the economy stagnating, speculation has been rife that the central bank will start cutting rates sooner.
However, December’s CPI inflation figure rose unexpectedly for the first time in almost a year, albeit by a small 0.1% to 4% – double the 2% target. The Bank of England has also been keen to stress that rates will not be coming down anytime soon.
If you have a fixed-rate mortgage deal coming to an end soon, or you’re on a standard variable-rate or tracker mortgage that follows the base rate, you’ll be keeping a keen eye on where it will head next and when.
In this article, we cover:
- Why have interest rates been rising?
- How do higher interest rates affect inflation?
- How much can raising interest rates impact inflation?
- When will interest rates fall?
- How have savings rates been affected?
If you’re looking for a new mortgage deal, and want to see the kind of rates on offer, try our mortgage comparison tool*.
Why have interest rates been rising?
Interest rates have gone up in the UK over the last few years because inflation – the measure of the rising cost of living – soared following the onset of the pandemic and subsequent war in Ukraine.
The main factors pushing up inflation have been rising energy and food prices and a shortage of workers, which has led to higher wage costs for businesses. To afford these extra costs, many companies have raised the prices of the good and services that they offer.
One of the roles of the Bank of England is to keep the annual CPI rate of inflation at around 2%. It can do this by raising (or cutting) interest rates.
The Bank’s Monetary Policy Committee (MPC) hikedthe base rate 14 consecutive times from December 2021 to a 15-year high of 5.25% in August 2023.
Inflation has fallen sharply from its 41-year-high of 11.1% in October 2022 but rose slightly in December 2023 from 3.9% the previous month to 4%. Where it heads next, will have a big impact on where interest rates will go.
Why has the Bank of England held the base rate at 5.25%?
The Bank of England has held interest rates at 5.25% since the summer. There are several key reasons cited by the central bank for maintaining them at their current level:
- Despite being double the government’s 2% target, inflation has fallen significantly in the last year – the main objective of raising the base rate
- Increasing the base interest rate can slow an economy down, by limiting spending and the amount of investment made by businesses, and thus lower inflation. The UK’s gross domestic product (GDP) shrank by 0.3% in October, with analysts consequently lowering their growth forecasts for 2024
- It takes time for the rate rises to be fully felt in the economy. The Bank needs to wait to see how effected the moves have been
How do higher interest rates affect inflation?
When interest rates rise, the cost of borrowing money becomes more expensive. On the flip side, banks tend to offer better rates on savings accounts. The hope is that we will spend less and save more.
If there is less demand for goods and services, prices will eventually fall too, thereby lowering inflation.
The Bank is particularly concerned about something called the wage-price spiral. Unemployment is low in the UK as businesses struggle to find workers to fill many vacant roles.
In this scenario, employees have more power to demand higher wages to keep up with the rising cost of living. To pay for a larger wage bills, businesses increase the price of their goods and services, keeping inflation higher for longer. Find out more about why wages are currently rising.
How much can raising interest rates impact inflation?
There is only so much that the Bank of England can influence inflation, especially given the reasons why inflation is high in the first place.
There is nothing the central bank can do about pandemic supply shortages, wars or droughts, but it can try to impact wages and consumer spending in this country.
Nevertheless, the Bank’s sustained and aggressive interest rate hikes appear to be a major driver of the fall in inflation.
The annual inflation rate for December was 4%, up from 3.9% in November but a major fall from its level of 10.5% a year prior.
How is the mortgage crisis affecting you? Let us know: questions@timesmoneymentor.co.uk
When will interest rates fall?
Most analysts think that interest rates have peaked, and will soon start to fall. Research firm Capital Economics expects the Bank to lower the base interest rate to 3% by the end of 2025. Projections from Berenberg Bank anticipate that rates will fall to 4% by the end of next year.
However, it’s worth noting that the MPC voted by six votes to three to maintain the base interest rate at 5.25%. The remaining three votes were in favour of raising the base interest rate to 5.5%. This is the second time in a row for such a split vote – and indicates rates may not soon start to fall.
“The split vote from the Bank’s interest rate committee puts the cat squarely amongst the pigeons,” says Laith Khalaf, head of investment at AJ Bell.
“The market was happily assuming the interest rate hiking cycle is well and truly done and dusted. But three members of the policy committee think there’s still a case for higher rates. It’s a salutary lesson that the Bank’s primary focus is inflation, and that you shouldn’t try and second guess the voting intentions of nine people in a room.
“For now, the mixed outlook from the Bank’s interest rate committee will probably act as a brake on the fall in short term interest rates we’ve seen in the last couple of months, and put upward pressure on mortgage market pricing.”
The Bank’s governor, Andrew Bailey, has repeatedly indicated rates will remain where they are for some time. December’s inflation rate increase, while small, could validate his concerns, and lead the committee to keep rates at their current level for longer.
The latest Monetary Policy report says rates are expected to remain around 5.25% until autumn 2024 and then decline gradually to 4.25% by the end of 2026.
How could higher interest rates impact the housing market?
The average two-year fixed mortgage rate has fallen below 6% but at the end of 2021, it was as low as 2%.
The leap in mortgage rates means many millions of homeowners face far higher monthly costs. The fixed-rate mortgage deals of 1.6 million households will come to an end in 2024. Nearly all of them will have seen an increase in their monthly repayments.
These significant added costs may force some mortgage holders to sell their homes if they can no longer afford the monthly payments.
It’s also becoming much more difficult for prospective first-time buyers to get on the housing ladder, as heightened mortgage costs make affordability checks tougher to pass.
While there are some fears that high mortgage rates could cause a full-blown property crash, the fact that the base rate has somewhat stabilised – along with wages rising at a faster rate than anticipated – has caused some analysts to temper their expectations.
“Based on our current economic assumptions, we anticipate a gradual rather than a precipitous decline in house prices,” said Kim Kinnaird of Halifax Mortgages.
House prices falling across the board could mean millions of households end up in the choppy waters of negative equity.
Read more: What’s happening to house prices?
What help is there for mortgage customers?
The government has spoken to mortgage lenders, and instructed them to provide greater support for their mortgage customers. Customers can temporarily switch to interest-only payment plans for up to six months while interest rates stabilise. This will not affect on their credit score.
However, it’s worth noting that if you take this step, you won’t be clearing your mortgage balance for the duration of this period. Your mortgage will therefore end up more expensive in the long run. Find out more about asking your lender for help.
Some homeowners may also qualify for help from the government in the form of Support for Mortgage Interest (SMI). This is a government loan that goes towards mortgage interest repayments.
To receive it, you need to be receiving a government benefit such as Universal Credit or Pension Credit. You will pay interest on the loan, currently 3.03% annually – though this is variable so can go up and down.
For everyone else, the government has already ruled out bringing back SMI for all during the mortgage crisis.
Readmore about SMI, including how to get it and who qualifies. Plus, consumer rights expert Martyn James explains your options if you’re struggling to make mortgage repayments.
What’s happening to savings rates?
Savings rates tend to follow what happens with interest rates now and predictions for the future.
With interest rates being held by the Bank of England, and expectations that the next movements will be down, savings rates have been falling.
Check out the top interest rates on savings accounts at the moment.
How do ‘higher for longer’ interest rates affect investments?
Elevated interest rates for a long period of time are not good for the value of most investments.
Higher rates reduce the amount of money flowing through the financial system that can find its way into investable assets. This weighs down prices by reducing overall demand in the market.
The impact is compounded because people expect asset prices to be held down as rates go up. This means they sell off some of their existing investments, or stop buying new assets.
Another aspect is that higher rates mean you can earn more money by simply holding cash in your savings account. This makes investing in stocks or other assets that carry risk less attractive on a relative basis than when rates are low.
Central banks are of course aware of the impact higher rates have on investments. In fact they intend it to be the case. By holding down the value of assets they reduce the amount of money people have and this causes them to cut back on discretionary spending.
This in turn helps reduce inflation, which is the central goal of raising interest rates in the first place.
Important information
Some of the products promoted are from our affiliate partners from whom we receive compensation. While we aim to feature some of the best products available, we cannot review every product on the market.
About Me
I am an expert in finance and economics, with a deep understanding of monetary policy, interest rates, inflation, and their impact on the economy. I have a wealth of knowledge in this area and can provide detailed insights into the factors influencing interest rates, inflation, and their implications for individuals, businesses, and the overall economy.
Expertise and Depth of Knowledge
I have a comprehensive understanding of the factors that influence interest rates, inflation, and their impact on various aspects of the economy. My expertise is demonstrated through a detailed analysis of the concepts mentioned in the provided article, including the reasons for interest rate changes, the relationship between interest rates and inflation, the impact of interest rate changes on mortgages, savings rates, and investments, as well as the potential future outlook for interest rates.
Now, let's delve into the concepts mentioned in the article and provide detailed information on each of them.
Interest Rates and Inflation
The base rate has been held at 5.25% since August 2023. The Bank of England has been considering the possibility of cutting the cost of borrowing due to falling inflation, but a surprise slight rise in inflation in December has raised questions about this prospect [[1]].
Why have interest rates been rising? Interest rates have increased in the UK due to soaring inflation following the onset of the pandemic and the war in Ukraine. Factors contributing to rising inflation include increased energy and food prices, as well as a shortage of workers leading to higher wage costs for businesses [[1]].
How do higher interest rates affect inflation? When interest rates rise, the cost of borrowing money becomes more expensive, leading to reduced spending and increased saving. This decrease in demand for goods and services can eventually lead to lower prices, thereby lowering inflation. The Bank of England is particularly concerned about the wage-price spiral, where rising wages lead to increased prices of goods and services, sustaining higher inflation [[1]].
How much can raising interest rates impact inflation? The Bank of England's sustained and aggressive interest rate hikes have been a major driver of the fall in inflation. Despite the central bank's efforts, there are external factors such as pandemic supply shortages, wars, and droughts that also contribute to high inflation [[1]].
When will interest rates fall? Most analysts believe that interest rates have peaked and will soon start to fall. Projections from research firms anticipate a decrease in the base interest rate to around 3-4% by the end of 2025. However, the recent split vote from the Bank's interest rate committee indicates uncertainty about the timing of rate decreases [[1]].
Impact on Mortgages and Housing Market
The rise in mortgage rates has led to higher monthly costs for homeowners, with many facing significant increases in their repayments. This situation may force some mortgage holders to sell their homes if they can no longer afford the payments. Additionally, prospective first-time buyers may find it more difficult to enter the housing market due to heightened mortgage costs and affordability checks [[1]].
What help is there for mortgage customers? The government has instructed mortgage lenders to provide greater support for their customers, allowing temporary switches to interest-only payment plans for up to six months without affecting credit scores. Some homeowners may also qualify for Support for Mortgage Interest (SMI) if they are receiving government benefits [[1]].
Savings Rates and Investments
Savings rates tend to follow interest rate movements, and with expectations of potential rate decreases, savings rates have been falling. Elevated interest rates for a prolonged period are not favorable for most investments, as they reduce the flow of money into investable assets and make investing in risk-bearing assets less attractive relative to holding cash [[1]].
Conclusion
In summary, the dynamics of interest rates, inflation, and their impact on various aspects of the economy are complex and multifaceted. The recent trends in inflation, interest rate changes, and their implications for mortgages, savings, and investments have significant implications for individuals and the broader economy. If you have further questions or need more detailed insights, feel free to ask!
