UK interest rates rose by 0.5 per cent to 2.25 per cent on 22 September as part of a bid by the Bank of England (BoE) to temper soaring inflation, placing it at its highest level since the global financial crisis of 2008.
The decision by the institution’s Monetary Policy Committee (MPC) was widely expected but had had to be delayed out of respect for the late Queen Elizabeth II and the ensuing period of national mourning.
The BoE said it now expects a 0.1 per cent fall in GDP over the current quarter, indicating that the country is already in a recession, an outcome governor Andrew Bailey has said in August Britain would have to walk “a very tight line” to avoid.
In a statement announcing its decision, the BoE said: “In the August Monetary Policy Report, the MPC noted that the risks around its projections from both external and domestic factors were exceptionally large, given the very large increase in wholesale gas prices since May and the consequent impacts on real incomes for UK households and on CPI [Consumer Price Index] inflation.
“Since August, wholesale gas prices have been highly volatile, and there have been large moves in financial markets, including a sharp increase in government bond yields globally. Sterling has depreciated materially over the period.”
Previously, the Office for National Statistics revealed on 14 September that the rate of CPI inflation had fallen to 9.9 per cent in August, down from 10.1 per cent in July.
Although experts had predicted that the figure would remain unchanged in August, downward pressure was put on the inflation rate by the falling price of fuel.
Here is a quick and easy guide to how the interest rate change will affect you.
What are interest rates?
An interest rate is a measure that tells you how high the cost of borrowing money is, or how high the rewards of saving are.
If you are borrowing money, typically from a bank, the interest rate on that money is the amount you will be charged for borrowing it.
It is a charge on top of the total amount of the loan and will be shown as a percentage of the overall.
Higher percentages mean paying more money to the lender for borrowing the money.
If you are saving money in a bank account, the interest rate on that money is the amount you will accrue on top of your savings. Banks will pay you a percentage of your total savings, typically at the end of the year.
How do interest rates affect inflation?
Low interest rates are used to discourage people from piling up their money in savings. High interest rates encourage saving because people get a better return for the money you are putting away.
This in turn has an affect on the price of goods.
When interest rates are low, people might spend more and this might cause retailers to put up the price of goods.
When rates are high, demand might fall as people put more money into their saving pots. This, in theory, should drive down the prices of good and services.
However, rising prices are not a direct result of interest rate changes. Other things, including the supply of money and underlying costs, affect prices and cause inflation.
Interest rates can only help manage inflation.
How do interest rates affect mortgage rates?
Changes in the BoE’s base rate, which is the interest rate at which high street banks borrow from Threadneedle Street, has a knock-on effect on the interest rates that the former then set their mortgage borrowers.
How does this affect me?
The changes in interest rates will affect anyone with savings and anyone who is borrowing money from the banks, for example in a mortgage.
It will also have a wider effect on the economy. By raising the base interest rate, the BoE is hoping to temper soaring inflation and help with the cost of living crisis.