The Bank of England (BoE) has raised its key interest rate to 5.25%, a level not seen in 15 years. Economists had largely expected the quarter-percentage point increase, marking it as the 14th consecutive hike by the central bank. According to the bank, the driving force behind this move is the realization that certain risks stemming from inflation, such as the surge in wages, have started to materialize. Consequently, they felt compelled to increase borrowing costs to address these concerns.
Bank of England looking to reduce inflation
There have been concerns among financially strained households and businesses that the Bank of England might repeat its substantial half-point increase, as seen in June. However, these worries were alleviated by recent figures indicating that inflation had decreased more than expected to 7.9%. This decline eased the pressure on the bank to take such aggressive measures again.
According to the Bank of England’s latest forecasts, they anticipate inflation to decrease further to 4.9% by the year’s end, with a moderation in food price increases. Bank Governor Andrew Bailey has expressed optimism about the falling inflation, recognizing its disproportionate impact on the most vulnerable individuals. The ultimate goal is to ensure inflation returns to the 2% target.
Considering that inflation is still four times higher than the target, it is widely anticipated that the bank will raise interest rates again, potentially in September, before pausing to let the previous increases affect the economy. It’s important to note that the effects of higher interest rates may take some time to manifest, particularly in the housing market, where many households will have to refinance their mortgages at higher costs in the coming months.
Bailey earlier expressed caution about prematurely declaring an end to the current situation and advocating for a continued evidence-driven approach. The bank’s recent statement has dashed hopes of a swift reversal in their policy. The language suggests that they intend to maintain borrowing costs at a level of sufficient restrictiveness for an extended period to bring inflation back to their target level effectively.
UK inflation stubborn compared to the US and the eurozone
In contrast to the United States and the eurozone, where inflation rates are significantly lower, the U.K. faces a more challenging inflationary environment. The U.S. and European Central Banks have recently raised rates as well. Still, they may be closer to considering a change in direction due to their relatively lower inflation rates of 3% and 5.3%, respectively.
Notably, the decision to raise interest rates is a global response shared by central banks as they grapple with inflation pressures resulting from increased energy prices following Russia’s invasion of Ukraine and supply chain disruptions due to the post-pandemic economic recovery.
While higher interest rates can help control inflation by making borrowing more expensive for consumers and businesses, it may also weigh on economic growth. However, the Bank of England seems optimistic that the British economy will avoid a recession in the coming years despite these measures. Bailey admits that the economy’s growth has shown greater resilience than anticipated, and he emphasized that the country has not experienced a recession or had a forecast indicating so.
Meanwhile, many individuals have yet to fully feel the impact of interest rate hikes. Unlike in the United States, where homeowners often lock in mortgage rates for more extended periods, most homeowners in Britain have relatively shorter fixed-rate mortgage deals. As a result, those whose mortgage deals are about to expire will soon face significantly higher borrowing costs.
Approximately 2.5 million mortgage deals will expire by the end of the next year, leaving around a million households potentially dealing with a substantial £500 ($640) increase in their monthly mortgage repayments by 2026, as highlighted by Bailey.
The pass-through of the recent Bank of England interest rate increases to existing mortgages has been limited. Michael Saunders, a senior economic adviser at Oxford Economics and a former rate-setter at the Bank of England, noted this aspect, indicating that the full impact of the interest rate hikes on outstanding mortgages has yet to be fully realized.