According to Trading Economics, the Bank of England raised the key bank rate by 25 bps (basis points) to 0.5% in February 2022. It’s the first time it has happened since 2004. Meanwhile, the Central Bank expects inflation to hit the market in the coming months. This means that interest rates will also increase in 2022, and it’s crucial to find fixed rate investments to avoid sacrificing your savings due to the upcoming inflation. This is especially true if you currently have a variable rate mortgage, as the rise of interest rates directly impacts variable rate mortgages.
If you remember, it was only two years ago that the British government had to rescue investors and nearly went bust. Since then, it’s been a slow recovery for markets worldwide, and in 2022, the consequences are about to hit everyone back. This rate change isn’t exclusive to the UK, and experts believe it’ll keep rising.
The key bank rate explained
The key bank rate fixed by the Bank of England directly impacts everyone. It’s the rate that commercial banks use for the interest they’ll charge on services like mortgages or loans.
The Bank of England organises meetings with its committee, the MPC. The MPC (Monetary Policy Committee) announces this rate eight times a year after several meetings. With inflation on the rise (5.5% in January 2022), the Bank of England decided to increase the interest rate to try and slow down this inflation.
How does raising interest rates slow down inflation?
If interest rates are low, companies and individuals will tend to borrow more because it’s cheaper. The downside is that lower interest rates lead to inflation, meaning your currency loses purchase power. The consequence of inflation is that goods and services become more expensive.
On the other hand, if interest rates are high, people will prefer to save money instead of borrowing, which helps to keep inflation more steady. In this case, your money will keep the same purchase power, and it’ll slow down the rise of prices.
The Bank of England has to adjust
The financial market is globalised, and the Bank of England isn’t just raising the interest rate because they want to. This decision was inevitable because, on the other side of the Atlantic, the US experienced its most significant inflation surge since 1982 with 7.2% last January. Many financial experts think the Federal Reserve is going to raise the US interest rate by 2% by May 2023. Decisions made by the US directly impact the UK because they’re the largest export market and this dependence also applies to most western countries.
What does the rise mean for businesses?
One of the critical changes in the rise of interest rates is the offer/demand ratio change. There’ll be less demand with higher rates simply because consumers will be incentivised to spend less and save more. It won’t affect every business the same way, but the first sectors to suffer from it are the ones where purchases are funded with credit, such as housing or car markets.
However, the lending rates don’t just rise and fall with the rate set by the Bank of England. The long-term lending rate considers several factors, including the risk implied by the borrower and the predictions on the future rate. This is why, even when the Bank of England cut the rate back in 2020, credit card and overdraft rates still rose.
Is there good news?
Yes, amidst all the crises the world seems to go through, lately, there are two excellent pieces of news. The good news for you is that, while borrowing will be more expensive, saving rates will get better. The other good news is that if you’re in the market to buy a house, prices will most likely be reduced by 2% to 11%, according to the Bank of England’s deputy governor.
However, if you have a variable rate mortgage deal, your rate will be impacted directly by the rate change. So, if you’re on the verge of remortgaging, it may be time to consider negotiating a fixed rate deal before it goes up again.