The BoE monetary policy committee (MPC) voted by a majority of eight to one, to increase rates from the historic low of 0.10% to 0.25%. Pressure on surging inflation outweighed the risks to the economy from the new Omicron variant. The BoE also stated that inflation could reach 6% by spring next year.
This was the first interest rate rise since August 2018 and comes after the BoE slashed rates to a record low (0.10% in March last year) in the jaws of the first wave of coronavirus, as lockdowns descended on the UK.
How do interest rates affect me?
Setting interest rates is one of the many ways the BoE tries to control the UK economy. When interest rates rise, it can make borrowing more expensive - especially for homeowners with mortgages. That said, it can also give savers a better return, although this is somewhat muted with returns still lagging due to surging inflation. Nonetheless, an increase in interest rates is usually passed on to some extent by individual banks. Let’s say the additional 0.15% is passed onto savers – this would mean receiving £30 more a year in interest based on a £20,000 of savings. In any case, this gain would be potentially wiped out by inflation.
Some mortgages – referred to as ‘trackers’ - are directly linked to the BoE base rate. The decision to raise interest rates to 0.25% will add just over £15 to the typical monthly repayment for a tracker-mortgage.
Someone on a fixed-rate mortgage may also find their next deal is more expensive (or cheaper) depending on how BoE interest rates have changed since their last deal.
As well as mortgages, this also influence the interest rates charged on other forms of credit, such as credit card loans, bank loans, and car finance. Therefore, changes in interest rates could still have an impact on your finances, even if you don’t have a mortgage.
What is inflation?
Inflation is a measure of how much the prices of goods (such as food or televisions) and services (such as train/bus tickets) have gone up over time. Usually, people measure inflation by comparing the cost of things today, with how much they cost a year ago. The average increase in prices is known as the ‘inflation rate’.
Another pertinent example on inflation is around cash savings, and the impact interest rates have on your savings over the longer-term. Let’s say a saver is earning 0.30% in interest against £20,000 – that’s £60 in interest per annum. With inflation currently at 5% - your buying (purchasing) power over the longer-term is reduced dramatically. In other words, you're now able to buy less with your money. Using the example cited – this would mean an effective reduction of 4.7% p.a.
So, if inflation is 5%, it means prices are 5% higher (on average) than they were a year ago. For example, if a jar of jam cost £1 a year ago and now it’s £1.05, then its price has risen by 5%.
What is the inflation target?
The BoE will raise, or lower interest rates to help maintain its 2% inflation target.
If prices - sometimes known as the cost of living - are rising faster than 2% a year, the BoE will consider putting up interest rates. The latest figures show the cost of living surged by 5.1% in the 12 months to November, the highest annual rise since September 2011.