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16 December 2021

What does the interest rate rise mean for the UK economy, house prices and savings?

The Bank of England's decision to hike rates will have a minimal impact on borrowers and savers – but more rises may be on the way.

By Will Dunn

The Bank of England’s Monetary Policy Committee has today (16 December) raised interest rates for the first time in more than three years from 0.1 per cent to 0.25 per cent. While interest rates remain historically low, this will have knock-on effects on house prices, savings and the wider economy.

Why has the Bank of England raised interest rates?

The rise comes in response to data released yesterday showing that inflation for the 12 months to November, as measured by the Consumer Price Index – which effectively measures the speed at which prices are increasing – had risen to a ten-year high of 5.1 per cent. Interest rates are used by the Bank to stimulate the economy (reducing them makes debt cheaper, encouraging spending by businesses and people) or to stop it from overheating (raising them makes debt more expensive, reducing demand and preventing further price rises).  

A month ago, the Monetary Policy Committee held interest rates and said it expected inflation to peak at 5 per cent in the spring, but that peak has already been exceeded. In his letter to the Chancellor Rishi Sunak this morning the Bank’s governor Andrew Bailey wrote that he now expects the peak to be more like 6 per cent in April. Hiking interest rates is a fast reaction to fast inflation: while a rise was widely expected, today’s announcement is “surprising”, said Suren Thiru, head of economics at the British Chambers of Commerce, “given mounting uncertainty over the economic impact of the Omicron variant”.

What’s driving inflation?

The current period of inflation is not unique to the UK. Around the world, the pandemic has caused three things to happen: massive injections of new money by central banks, changes in consumer behaviour and disruption to manufacturing and supply chains. This means there’s a lot of money sloshing around, but also shortages of products and labour, from second-hand cars to gas to HGV drivers, causing prices to spike.

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Will a rise in interest rates cause house prices to crash?

The higher bank rate will feed into rates for new mortgages, making it slightly more expensive to buy a house and limiting demand. It’ll also be more expensive to remortgage, which might encourage some homeowners to downsize. Most mortgages (around three-quarters), and almost all new mortgages, are fixed-rate deals; only homeowners with “tracker” mortgages, which rise or fall with the base rate, will receive higher bills immediately.

Nicky Stevenson, managing director at estate agents Fine & Country, said she found the timing surprising “amid the current uncertainty”, but that a rate rise had been expected for some time and “markets are currently pricing in further increases to around 1 per cent before the end of next year”.

A rise of 0.15 percentage points is unlikely to put first-time buyers off, especially as the rise in rent prices has hit a 13-year high, making renting more expensive (as a proportion of income) than owning. Plus, the interest rate was 0.75 per cent before the pandemic, before the Bank of England slashed it to 0.1 per cent in March 2020 – so most people should still be able to afford to borrow.

In another sign that further rate rises are likely, the Bank is also looking at relaxing the affordability requirements on mortgages, so people can sign up to spend an even higher proportion of their income on housing and the market can remain madly, pointlessly overheated for some time yet.  

Will savers feel the benefit?

It depends on the kind of savings. New savings accounts will offer higher rates, but again, not much higher, and certainly not above the current high level of inflation. As a very general rule, rising interest rates also tend to reduce stock market returns (because it becomes more expensive for listed companies to borrow and invest) and cause bond prices to fall. This could mean that other investments, such as stocks and shares ISAs or pension funds, don’t increase in value as they would have done.

Older savers could be better off: those who buy an annuity with their pension will receive higher monthly payments, as annuity rates are determined by interest rates and the yields from government bonds (which rise when interest rates go up).

Should I cut up my credit card, burn it and dissolve the ashes in a caustic substance?

Yes! Not because the Monetary Policy Committee has raised the base rate by 0.15 per cent, but because banks have raised interest rates on credit-card borrowing to well over 21 per cent. The rise in the base rate will only give credit card providers more reason to increase these rates, which are already at a 23-year high.

Pre-existing fixed-rate loans, like fixed-rate mortgages, are of less concern, although rates offered on new loans should also be expected to rise.

[see also: Inflation is at a ten-year high – what does this mean for you?]

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