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In light of the latest figures on inflation, with a jump to 10.4% during February, the Bank of England (BoE) has once again decided to raise UK interest rates by 0.25%, taking the current rate of interest to 4.25%, its highest figure since the banking crisis of October 2008.

The BoE’s Monetary Policy Committee (MPC) sets monetary policy to meet its target of 2% inflation. The level of the interest rate is also meant to help sustain growth and employment. At its meeting ending on 22nd March 2023, the MPC voted by a majority of 7:2 to increase Bank Rate by a quarter of a percent, with two members advocating that it be held at 4%.

The increase, whilst being only half the rate of the BoE’s recent interest rate hikes, highlights the central bank’s continued struggle to tackle stubbornly high inflation against a deepening cost-of-living crisis. “CPI inflation increased unexpectedly in the latest release, but it remains likely to fall sharply over the rest of the year. Services inflation has been broadly in line with expectations, The Bank will adjust Bank Rate as necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit” It said.

BofE Intrest Rate Rise: A high-wire act

The rise also mirrors the US Federal Reserve’s recent decision to raise interest rates by 0.25%. However, with the failure of 3 US banks, as well as the concerning collapse of Swiss banking giant Credit Suisse, governments are now walking a tightrope between on one hand, trying to reduce spiralling inflation and on the other, supporting an embattled banking sector during a tumultuous financial period.

The ever-rising interest rates have been a major reason why Silicon Valley Bank, Credit Suisse and others have got into difficulties. And, with spooked markets echoing worries of contagion spread, the BoE, as well as many other central banks, are likely to be feeling the pressure.

The problem for all central banks is that they know from experience that significant hikes in interest rates will reduce demand and thus lower inflation, but the other side of the coin is that more hikes will mean a growing number of thusfar ‘safe’ banks starting to struggle.

The BoE have however, struck a fairly positive tone following the recent rise, with the MPC judging that despite the recent problems in the banking sector “the UK banking system maintains robust capital and strong liquidity positions, and is well placed to continue supporting the economy in a wide range of economic scenarios, including in a period of higher interest rates.”

BofE Interest Rate Rise: Why are many banks struggling?

For banks, the risks associated with rapidly rising interest rates arise from the fact that majority of their liabilities are short term (instant demand current and savings accounts) whilst most of their assets are long-term. The majority of the long-term assets are mortgages and loans, the bulk of which are at fixed rates such as government bonds which typically have a maturity date of 10 to 30 years.

The knock-on effect is that a bank’s profitability can be negatively impacted. This is because its cost of funding is increasing, whilst its returns from long-term assets are reducing, largely because of inflation. This double whammy can lower the value of equity in a bank, which we’ve seen in recent weeks with the share price of most banks plummeting.

Image of Silicon Valley bank HQ text reads SVB's collapse sent jitters through the banking world

One of the many factors

Interest Rate Rise: BoE given no choice

The markets had expected the BoE to stand firm on its current figure of 4% after over two years of steady increases. The Chancellor Jeremy Hunt, in his recent Spring Budget announcement, also struck a positive tone, railing against a supposed “narrative of decline”. Meanwhile, the Office of Budget Responsibility said it expects the economy to contract by only 0.2% this year, rather than the 1.4% previously predicted.

Unfortunately, despite these positive thoughts, February’s inflation statistics left the MPC with little choice but to raise interest rates once again, as it makes its 11th consecutive rise in a desperate bid to reach its distant inflation target of 2%.

The recent surprise increase in inflation, follows three-months period of  steady falls from the peak of a gnat’s whisker under 12% back in October of last year, with the Office for National Statistics blaming the dramatic rise in fresh food, especially salad, and fruit/juices as the main drivers of the rise. This will have shaken the new Chancellor’s previously sunny disposition after his rallying cry against declinism, with both the public and MPs asking questions as to how the government plans to tackle the crisis.

BofE Interest Rate Rise’s Knock-on effects

  • Mortgages -After a period of ultra-low rates, many homeowners are now facing the likelihood of much more expensive monthly repayments, with around four million households facing a higher monthly mortgage bill this year. According to City watchdog the Financial Conduct Authority. When interest rates rise, more than 1.4 million people on tracker and variable rate deals usually see an immediate increase in their monthly payments of approximately £24 per month per ¼% rise.

This of course comes on top of increases following the previous recent rate rises. Compared with pre-December 2021, average tracker mortgage customers will be paying about £394 more a month, and variable rate mortgage holders about £251 more.

  • Savings – Individuals who have traditionally relied on savings interest as part of their income have been hit hard since 2008, with a typical savings rate being a fraction of 1% for nearly 15 years, with the added double-whammy of their nest egg falling in value, quicker quicker as inflation rises.

Whilst savings rates have always lagged behind the BoE rate, they are currently at their highest level for 20 years with the best rates currently at or close to 4%.

Tax Accountant’s view

I suspect February’s small rise in inflation is no more than a blip and I agree with both the BoE and most other experts, that by the Spring of next year we should see inflation at or close to the BoE’s target rate of 2%. However, given the pressure on banks, I also believe that whilst mortgage rates will certainly fall back they will never again be as low as they were a year ago.