Interest rates

What are they and how high can they go?

Woman using an ATM

The Bank of England will announce its latest decision on interest rates on Thursday and is expected to raise them for the sixth consecutive time.

Interest rates currently stand at 1.25%, but the central bank may raise them to 1.75%. If so, it would be its highest level since December 2008.

The Bank hopes to slow the rate at which prices rise. He warned that inflation could pass 11% later this year.

Why are prices and interest rates rising?

Prices are rising rapidly around the world as Covid restrictions ease and consumers spend more.

Many businesses have problems getting enough merchandise to sell. And with more buyers looking for too few properties, prices have risen.

There has also been a huge increase in the cost of oil and gas – a problem made worse by Russia’s invasion of Ukraine.

One way to try to control rising prices – or inflation – is to raise interest rates.

This increases the cost of borrowing and encourages people to borrow and spend less. It also encourages people to save more.

However, this is a difficult balancing act because the Bank does not want to slow down the economy too much.

Since the global financial crisis of 2008, UK interest rates have been at historically low levels. Last year, they were only 0.1%.

How high could interest rates rise?

Many analysts have predicted that UK interest rates will rise this month, but further increases are also expected later in the year.

Analysts at Capital Economics think the Bank will eventually have to raise rates to 3% to stifle inflation, but other economists think they won’t have to go that high. Pantheon Macroeconomics estimates that interest rates will peak at 1.75%.

Last year, the Office for Budgetary Responsibility (OBR) – the government’s independent economic adviser – looked at what could happen if the UK were to experience higher and longer lasting inflation.

This can happen when people think prices will continue to rise – companies are raising prices to keep making profits and workers are demanding wage increases to keep up.

If that happens, UK interest rates could hit 3.5%, the OBR said.

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interest rate chart

How do interest rates affect me?

Mortgages

Just under a third of households have a mortgage, according to the English Housing Survey, which is geographically limited but one of the most comprehensive guides available.

Of these, three quarters have a fixed rate mortgage and will therefore not be immediately affected. The others – about two million people – will see their monthly payments increase.

If rates rise to 1.75%, those with a typical trailing mortgage will have to pay around £52 more per month. Those with standard variable rate mortgages will see an increase of £59.

This comes on top of increases following other recent rate hikes.

Compared to before December 2021, tracker mortgage customers could pay around £167 more per month, and variable mortgage holders around £132 more.

Credit cards and loans

Even if you don’t have a mortgage, changes in interest rates could still affect you.

Bank of England interest rates also influence the interest charged on things like credit cards, bank loans and car loans.

Even before this latest hike, the average annual interest rate was 20.23% on bank overdrafts and 18.56% on credit cards in June. Lenders may decide to increase these fees now that interest rates have risen.

Savings

Bank decisions also affect the interest rates people earn on their savings.

Individual banks generally pass on any interest rate hikes, giving savers a higher return on their money.

However, for people who put money aside, interest rates do not keep up with rising prices.

How does the Bank of England set interest rates?

Interest rates are decided by a team of nine economists, the Monetary Policy Committee.

They meet eight times a year – about once every six weeks – to review the performance of the economy.

Their decisions are always published at noon on Thursdays.

Are other countries raising their interest rates?

The UK is affected by rising prices across the world. There is therefore a limit to the effectiveness of interest rate hikes in the UK.

However, other countries are taking a similar approach and have also raised interest rates

The US central bank has announced significant rate hikes over the past two months. The Federal Reserve raised rates by three-quarters of a percentage point in June and then again in July, in a range of 2.25% to 2.5%.

The European Central Bank also hiked rates for the first time in more than 11 years, while Brazil, Canada, India, Australia and Switzerland also raised their rates.

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