Interactive Investor

Interest rates rise by 0.25%: how will it affect me?

16th June 2022 12:59

Alice Guy from interactive investor

Alice Guy examines the Bank of England’s 0.25% interest rate rise, explains why rates are rising and what it means for savers and investors.

Interest rates are going up by 0.25%, as the Bank of England today announces their much-anticipated decision on the base rate. The central bank's Monetary Policy Committee (MPC) voted by a 6 to 3 majority to raise the cost of borrowing by 0.25% to 1.25%.

It follows their decision in May to raise rates by 0.25% and means that in total, rates have climbed by 1.15% since their low point of 0.1% where they had stood between March 2020 and January 2022.

More interest rate rises are expected in the next few months as the Bank of England tries to bring rampant, near double-digit inflation, under control.

Why are rates rising?

In May, inflation surged to 9%, the highest level since 1982, and the cost of living is expected to hit double digits in the next few months.

After a period of historically low interest rates, the Bank of England is now gradually increasing rates to try and pull back inflation to nearer its target of 2%.

Inflation is a problem across the world and the Federal Reserve in the US yesterday announced a rate rise of 0.75%, the biggest single increase since 1994, to bring total rates across the pond to 1.75%.

Interest rates and inflation are closely linked as raising interest rates can reduce consumer and business spending and therefore help pull down prices. However, increasing interest rates too quickly could bring the economy to an abrupt halt and trigger a recession.

The Bank of England Monetary Policy Committee had opted for a softly, softly approach, hoping that gradually increasing rates will slowly bring down inflation and prevent the need for a big hike in rates further down the track.

How high will interest rates go?

It’s difficult to predict how high rates are likely to go. It depends on how the economy and inflation reacts over the next few months to action taken now. Most experts agree that further rate rises are likely and interest rates could climb as high as 2.5% by 2023.

However, we’re unlikely to see a return to the ultra-high interest rates of the 70s and 80s. That’s because those interest rate hikes followed a very long period of high inflation throughout the 1970s.

In contrast, if economic forecasts are correct, the current period of inflation is likely to be fairly short-lived and inflation will be back to 4.8% by 2023, according to data from Capital Economics.

Effect on mortgages and debts

Mortgages are closely tied to the Bank of England base rate. That’s because lenders borrow money from other banks so they can pay it out to customers.

If you’ve agreed a fixed-rate on your mortgage, then you’ll have some breathing space. But if you’re on a floating or variable deal then you will end up paying more in interest charges. Someone with a £200,000 mortgage could end up paying £500 more per year due to the rise in rates.

If you’re trying to pay off debt, then the interest rate rise may not affect you. Short-term loans are usually fixed at a much higher rate than the Bank of England base rate, so a small change probably won’t affect your rates. Check your terms and conditions to find out more.

Should I fix my mortgage?

If your mortgage deal is ending, or you’re about to move home, then you might want to consider a long-term fixed-rate mortgage. Even with the 0.25% rise, interest rates and mortgage deals are still at a historic low and are unlikely to drop any further. Fixing your rate will also give you certainty around your mortgage costs, which is one thing less to think about when so many costs are rising.

Effect on savings and investments

For savers and investors, returns on cash are still extremely disappointing. The rise in rates may mean that there are more offers around for cash savers, however, interest is still unlikely to beat inflation any time soon.

If you’re an investor with a stock portfolio, then the picture is a little more complex. Interest rate rises tend to have a dampening affect on share prices, but in this case the rise was already expected and is now baked into share prices.

However, with many interest rate rises potentially coming down the track, it’s likely that stock market volatility will continue for some time. Economic forecasts and expected interest rate changes often cause stock market movement: a sell off if the economic outlook is worse than expected and a rally if figures beat expectations.

Sit tight because we’re in for a bumpy ride!​​​​​​

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