How big a rate hike will the Bank of England deliver?

The last UK interest rate decision took place on the eve of the mini-budget in September, and a fair bit has happened since then.

Markets got seriously spooked by the potential for the Bank of England to dramatically tighten monetary policy in response to the government’s tax and spending plans. But since the reversal of the mini-budget, the case for additional interest rate rises has diminished, as the Treasury is no longer pushing in the opposite direction to the Bank of England.

Make no mistake, interest rates are going up from here, but the government’s climb down from the inflationary policies of Trussonomics means the Bank won’t have to slam down on the brakes quite as hard.

Laith Khalaf, head of investment analysis at AJ Bell, looks forward to next Thursday’s interest rate decision from the Bank of England: “In terms of the immediate policy decision, the market is now pricing in a 0.75% interest rate rise at the next meeting. The delay to the new chancellor’s fiscal statement will probably encourage the Bank’s rate-setters to be cautious with their November interest rate hike, because they’ll still be missing a big part of the economic picture. The Bank can always then adjust monetary policy at the December meeting if needed, when the full scope of the government’s fiscal plans will be laid bare by the Autumn Statement.

“The central bank is also due to begin selling gilts from the QE scheme on 1^st November, after pushing this date back to accommodate its pension scheme bailout in the wake of the mini-budget. This will mean the government paying more interest on those gilts than they have under the QE scheme, because buyers in the market will want to receive the full gilt coupon, whereas the Bank of England only charged base rate for its troubles. Ironically, the base rate itself is now moving upwards quickly, which significantly raises the interest cost to the government of the gilts that remain in the QE scheme. None of that is a welcome development for the new chancellor, who is already scrambling to plug a black hole in the Exchequer’s finances.

“Looking further out, the trajectory for UK interest rates is quite breath-taking, especially when you consider that at the beginning of last year the Bank of England was warning about the possibility of negative interest rates. Last November, the base rate still stood at 0.1%, and the central bank was predicting inflation would peak at 5% in April of this year. Now markets are pricing in base rate hitting 5% in 2023, and CPI inflation sits at a distinctly uncomfortable 10.1%.

“The upshot is that UK consumers are now facing a speedy and painful transition to a level of interest rates that have not been seen since the financial crisis. Clearly the greatest concern will be in the mortgage market, where a higher base rate will push up variable rate products. Fixed rate mortgages shouldn’t jump up significantly from already elevated levels, unless the Bank of England surprises the market with a larger than expected rate hike. The overall picture coming through loud and clear is that home ownership is set to become a lot more expensive for mortgage borrowers. This ripple of financial pain will spread out across the country gradually, as consumers roll off their existing fixed deals and find themselves at the mercy of current rates in the mortgage market.

“It’s an ill wind that blows no-one any good, and while mortgage borrowers may feel their pips squeaking, cash savers are finally enjoying returns that don’t begin with a zero. The top instant access account will now pay you 2.8% and the top one-year fixed rate savings account is paying 4.5%, according to Moneyfacts. You do have to shop around for the best rates and if you sit and wait for your high street bank to come up with the goods, you’re likely to be sorely disappointed. Against a backdrop of double-digit inflation, even today’s saving rates still aren’t enough to stop cash losing its buying power, but in the current economic gloom, it’s important to try and find some positives.”