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polar bear head water Oh no, not again! The interest rate rises to 5%

Interest Rate Rise

A week ago, Bank of England (BofE) Governor Andrew Bailey announced that The Bank had decided to increase the base rate by a half percent to an eyewatering 5%, the 13th consecutive time it had raised rates in the last eighteen months.

The monetary policy committee (MPC) of the BofE voted by a majority of 7-2 in favour of increasing the base rate by a bigger than expected percentage of 0.5%, following the news the day before, that showed inflation stubbornly remaining at 8.7% in May. The Bank has been gradually increasing interest rates from a low of less than 1% but thusfar has not been able to bring inflation anywhere close to its target of 2%.

Andrew Bailey commented, “All the advice we’ve received indicate that if the Bank did not raise rates now, it could be even worse later”. He then added, “I fully understand the difficulty and the pain that this rise will cause for many people.”

Chancellor Jeremy Hunt released a statement saying: “High inflation is a destabilising force eating into pay cheques and slowing growth. Core inflation is higher in 14 EU countries and interest rates are rising around the world, but the lesson from other countries is that if you stick to your guns, you bring inflation down. Our resolve to do this is watertight because it is the only long-term way to relieve pressure on families with mortgages. If we don’t act now, it will be worse later”.

Interest Rate Rise: Inflation stubbornly high

This week the central bank was pushed into a corner as figures from the office of national statistics showed that whilst inflation has dipped slightly since a peak of 11.1% in October 2022, it is still stubbornly high and has been stuck at 8.7% for two months.

The BofE’s approach mirrors that of America’s Federal Reserve, which has increased interest rates from near zero to 5.25%. In contrast to the Bank of England, the Federal Reserve kept interest rates unchanged last week when inflation dropped to 4.05% from a peak of 8.58% at the beginning of the year.

Andrew Bailey advised that the 8.7% inflation number was 0.5% higher than it expected only a month ago but said that despite the disappointing number, the bank remained firm in its belief that inflation will fall significantly further during the course of the year, reflecting further falls in energy prices.

The MPC’s commentary showed that it recognised that there will be “occasions when inflation will depart from the target as a result of shocks and disturbances” but the MPC will ensure that CPI inflation returns to the 2% target sustainably in the medium term (in layman’s terms – 3 to 5 years).

The central bank also said it will continue to monitor indications of persistent inflationary pressures in the economy and confirmed that it will adjust bank rate as necessary to return inflation to the 2% target and will enforce further tightening in monetary policy if there is evidence of more persistent pressures.

Interest Rate Rise: Reaction

Reacting to the news, Paul Surtees, the CEO of Capitalise, the business funding platform said: “The UK economy is now the inflation outlier in the G7 – putting huge pressure on the BofE to continue to increase rates from here, and I anticipate a revised market peak in rates of around 6%.”

Most lenders are of the opinion that even if inflation starts to fall rapidly, the rate rises will take nearly a year to play out. Clearly this is a dangerous time for both the central bank and our economy, as the majority of finance experts, together with the banks and building societies, realise that by pushing up rates significantly, they are at risk of the lagged impact of high rates forcing a recession and potentially a crash in house prices.

The fundamental problem is that as fixed borrowing (both domestic mortgages and commercial loans) becomes more expensive, demand will fall and inevitably jobs will be lost, and we could see the spectre of negative equity once more.

Interest Rate Rise: Has the Bank made a mistake?

The Bank of England is coming under increasing criticism for the way it has handled the rate rises, with many in the finance industry being of the opinion that the economic problems that we are now facing have at least in part, been created by Bank policy.

It is becoming increasingly clear that the Bank never really understood that interest rate rises could never fully address the inflation spike which began 18 months ago. This is because the spike was not caused by an overheating economy but rather the sudden impact of external forces, largely as a result of Putin’s war.

The Bank however, instead of looking at more innovative solutions to address the problem, instead relied on its historical preferred course of action, and put rates up anyway. So, in a classic example of ‘the law of unintended consequences’, we now have continuing inflation precisely because the cost of money has increased as a direct result of the higher official bank interest rate.

The economy is now in a classic monetary vicious circle, with interest rates and inflation chasing each other in a seemingly never-ending spiral, with the Bank seemingly unable to get off the merry-go-round.

Interest Rate Rise: What is the actual cost of borrowing?

According to leading comparison website uSwitch, the average standard variable rate (SVR) in the UK has now risen to 7.99%. You can of course obtain a lower rate if you fix, with the average two-year fixed-rate mortgage rate now at 6.44%, dropping to 5.79% if you fix for 5 years (rates based on 75% LTV).

But everything is a gamble at the moment, with most lenders expecting the official  bank rate of 5% to peak at or close to 6% later this year and then gradually fall back to around 3% by the end of 2026.

For businesses the rates are even higher, with even the big companies with good balance sheets, currently paying well into double digits for unsecured borrowing and with the lowest secured rates starting at 9%.

Tax Accountant’s view

Regrettably readers, I don’t have a cunning plan to get us out of this mess, my suggestion is that Jeremy Hunt and Andrew Bailey get together and accept that their seemingly blind obsession with hiking interest rates to solve the inflation problem, is actually making matters worse.

I can but hope; but in the meantime, both individuals and businesses will just have to hunker down and ride out the storm until the next base rate decision from the BofE, set for 3rd August 2023.