Bank of England raises interest rates to 3.5% - the highest level for 14 years - putting pressure on mortgages

The Bank of England has increased interest rates to 3.5%, putting further pressure on mortgages.

In a crunch meeting, the nine members of the Monetary Policy Committee decided to increase the base interest rate from 3% to 3.5%, its highest level for 14 years. This will push up the amount that millions of mortgage holders have to pay their banks every month.

Six members of the committee voted to raise the rate by 0.5 percentage points. Two members – Swati Dhingra and Silvana Tenreyro – voted in favour of holding rates at 3%, while another member, Catherine Mann, called for a firmer 0.75 percentage point increase.

The 0.5 percentage point increase represents a slight cooling in rate increases, after the Bank’s MPC opted for a 0.75 percentage point rise last month – the highest single increase since 1989. It will also be the ninth time in a row that the Bank has hiked interest rates. Less than a year ago the rate was 0.1%.

The Bank of England has said it now expects UK GDP to decline by 0.1% in the final quarter of 2022, which is 0.2 percentage points stronger than expected in last month’s report but would still show the UK entering a technical recession. It added that household consumption has remained “weak” and it has seen the housing market “continue to soften”.

Chancellor Jeremy Hunt said: “High inflation, exacerbated by Putin’s war in Ukraine, continues to plague countries across the world, eating into people’s pay cheques and driving up food and energy prices. I know this is tough for people right now, but it is vital that we stick to our plan, working in lockstep with the Bank of England as they take action to return inflation to target.

“The sooner we grip inflation the better. Any action which risks permanently embedding high prices into our economy will only prolong the pain for everyone, stunting any prospect of economic recovery.”

While Shadow Chancellor Rachel Reeves said the hike shows “the government has lost control of the economy”. The Labour frontbencher said it was “harming growth, and leaving millions of working people paying a Tory mortgage penalty for years to come”. She added: “After 12 years of Tory failure and wasted opportunities, only Labour offers the leadership and plans to stabilise our economy and to get it growing, so we aren’t just surviving, but thriving again.”

Governor Andrew Bailey sought to cool market expectations for how high interest rates will ultimately increase at the previous meeting, amid improvements in the value of the pound and government borrowing rates since September. Deutsche Bank has suggested that rates could push as high as 4.5% next year, drifting from the Bank’s own previous prediction of 5.25% last month.

However, experts at ING and Investec have been even more dovish, both predicting that the rate will peak at 4% next year. ING’s James Smith, Antoine Bouvet and Chris Turner said in a note to investors: “When the Bank of England hiked by 75 basis points for the first time back in November, it seemed obvious that it would be a one-off move. The forecasts released back then suggested that keeping rates at 3% would see inflation overshoot (just) in two years, while raising them to 5% would see an undershoot. In other words, we should expect something somewhere in the middle, and that’s why we think Bank Rate is likely to peak at 4% early next year.”

They predicted that interest rate hikes could stop in February but suggested that continued wage pressures in the labour market mean the Bank could be “less swift to cut rates than the US Federal Reserve”.

What is the Bank of England base rate?

The Bank of England base rate determines how much it costs to borrow money in the UK.

When you take out a mortgage or a loan, the lender will add interest. Some of this interest will be determined by how risky they deem the borrower to be, but much of it will be influenced by how much the lender needs to earn back to maintain the value of their initial loan - something that is directly influenced by the UK central bank’s base rate.

Given the UK has a target of keeping inflation (i.e. the decline in the purchasing power of the pound) to 2% - a percentage that economists believe helps to maintain a healthy level of supply and demand in the economy - the pounds in our pockets are always losing at least some of their value.

To keep inflation as close to this level as possible, the Bank of England - whose primary role is to look after the UK’s currency - raises and lowers the base rate accordingly.

Its Monetary Policy Committee (MPC), a group of senior economists from within the bank and the City of London, meets several times a year to look at the economy and decide the rate it will set.

How do interest rates affect inflation?

Interest rates and inflation have a direct relationship. When interest rates go up, inflation goes down - and vice versa.

The reason for this is that when money becomes more expensive to borrow, it restricts how much economic activity (i.e. spending) takes place. Businesses are less likely to take out loans they might use to invest in expansion, while housing market activity slows down because mortgages become more expensive.

At the same time, it becomes more lucrative to save money, which also reduces spending. It all means the Bank of England has to carefully consider how much to raise interest rates by - raise them too much and the UK could slip into a recession; lower them by too much and inflation could rocket.

What does interest rate rise mean for cost of living?

Inflation has reached record highs in recent months, reaching double digits. Energy bills were the main contributor to the percentage-point rise in the rate, despite the government’s energy price guarantee shielding consumers from the worst wholesale gas and electricity hikes.

Food prices have also continued to soar, and now sit at their highest inflation rate - 16.4% - since September 1977. Everything from milk to cheese and jam has become more expensive, with value items seeing some of the biggest hikes.

In theory, the interest rate rises should lower this high rate of inflation, but it may be some time before they feed through into shelf prices. The Bank of England predicts inflation will be back below its 2% target by 2025.

The key thing to remember is that even if inflation goes down, it still means prices are higher than they were previously and are still increasing. Also, with wages struggling to keep up with inflation and unlikely to catch up for a while yet, it means the cost of living will still be much more expensive than it was last year.

Another big problem at the moment is that the cost of living crisis is just one of the economic issues facing the UK. Most economists believe we’re already in a recession that could last until at least 2024, with the Bank of England saying last month that it could be the longest one on record.