The Bank of England has raised its base interest rate by a further 0.5% to 2.25%. Paul Gibson explains why and tackles other burning questions.
The Bank of England’s decision to increase its base interest rate from 0.5% to 2.25% means rates are at their highest level since 2008.
Why have interest rates increased when we are all already facing rising costs?
Global inflation has taken off this year for a variety of reasons, including the war in Ukraine, higher energy costs and global supply chain issues.
One of the tools available to the Bank of England is to increase interest rates to try to reduce both the supply of money in the economy and the impact of inflation, although this alone may not be sufficient in the current climate.
How high could interest rates go?
Although they are at a recent high, they are still well below the long-term average of 7.15% experienced from 1971 until 2022.
Rates have been as high as 17%, back in November 1979, and as low as 0.1% in March 2020.
There is clearly lots of room for rates to increase and the expectation is they will do so, albeit not to the extremes experienced in the 1970s.
What does it mean for savers?
Savers are now able to access rates in excess of 3%, particularly if they are willing to tie their funds up for at least a year.
Savings rates have been very low for a long time and the increase will surely be welcomed, particularly by those in retirement who have been starved of income with rates at effectively zero for so long.
The sting in the tale is, of course, UK inflation – as measured by CPI (the Consumer Price Index) – is currently 9.8%.
This rate has reduced slightly from 10.1% in the previous month but means “real” returns from cash deposits are still negative.
What will it mean for my mortgage?
The standard variable rate for mortgages, lenders’ most expensive rate, is likely to increase immediately.
Those on rates “tracking” the base rate will find their monthly payments are also going up.
Many people are still on fixed rates so will not be affected by the increases yet.
Those on fixed rates that are coming to an end will find new deals are substantially more expensive.
It is worthwhile shopping around for the best deals in the market when your rate is due to expire.
I am retiring soon so how will it affect me?
The number of people buying annuities with their pension funds at retirement has been reducing over the last decade.
This is due to the greater flexibility offered by “flexi access drawdown”, the ability to fully cash in small pots and the perceived poor value offered by annuity rates.
Annuity rates have increased substantially over the past year, partly as a result of increasing interest rates.
More people may now consider these for all or part of their retirement income, particularly as they get older and want to take investment risk off the table.
What happens next?
The next meeting of the Bank of England’s monetary policy committee is scheduled for November 3, when the quarterly inflation report will also be published.
The results of this may help decide where rates go next.
Paul Gibson is managing director at Banchory-based Granite Financial Planning.
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