The UK economy’s woes deepened on Thursday (22 September) after the Bank of England raised interest rates and announced it believes the UK has already entered a recession.
It comes as new Prime Minister Liz Truss has started to implement a political agenda centred around economic growth and ‘trickle down’ prosperity. The PM hopes these policies - including a potential cut to stamp duty - will help to solve the cost of living crisis and carry the UK out of recession.
Described by some as ‘Trussenomics’, she pushed forward her fiscal ideas at the UN General Assembly - although the reaction was not what she would have hoped for.
So what is the new interest rate - and what has the Bank of England said about its decision? Here’s what you need to know.
What are interest rates?
As the public body in charge of the UK’s currency, the Bank of England plays an important role in influencing inflation - i.e. the value of the pounds in our pockets - as well as how much it costs to borrow money.
Borrowing money is key to business growth and is also vital to the UK economy because it allows the housing market to function. Very few people can afford to purchase a property outright, with most relying on mortgages to pay for their new home.
All loans have a rate of interest attached. Most of this interest is intended to preserve the value of the money the lender has paid out.
The Bank of England base interest rate plays a major role in influencing the level at which inflation levels are set on the market.
When the interest rate is low, the cost of borrowing is cheap and therefore, money is more likely to move around the economy. This increases the rate of inflation as demand for goods and services is likely to increase above supply.
If the interest rate is high, it is more expensive to borrow money and more attractive to save. This measure is likely to decrease the amount of economic activity, which in turn lowers the rate of inflation.
The Bank of England has a target to keep inflation at a rate of 2%. Economists believe this level of inflation encourages consumers to spend without making the cost of living unaffordable.
Given inflation currently sits at near-40-year highs of 9.9% (as of August 2022), the UK’s central bank is trying to take the heat out of the UK economy by increasing its interest rate.
What is the new UK interest rate?
On Thursday 22 September, the Bank of England’s Monetary Policy Committee (MPC) met to decide whether to raise interest rates. This group includes the governor of the Bank of England Andrew Bailey, as well as other key economic figures at the central bank.
Over most of the past decade, it has kept rates at historic lows in a bid to fuel economic growth. For most of this period, successive Conservative governments pursued a policy of austerity, which meant they decreased public spending.
But in 2022, with inflation soaring, the UK’s central bank has introduced successive rises to its base rate. The latest increase has seen this rate rise to 2.25% from 1.75%.
This new rate is the highest Bank of England base rate since November 2008 - a time when the global Financial Crisis was at its peak.
The MPC’s minutes said it took “forceful” action because “tight labour with wage growth and domestic inflation” were all well above target.
It all means the cost of borrowing is likely to become more expensive. So, if you are a mortgage payer, you will be likely to see your repayments increase, particularly if you are on a variable rate mortgage rather than a fixed deal.
Repayments could well rise above the headline interest rate given the Bank of England base rate is not the only factor lenders use to determine the cost of a loan. For example, riskier loans tend to have heftier interest rates as the lender will seek to guard against losing money.
Trade association UK Finance has released figures that show mortgage payments for borrowers with base rate tracking deals could jump £49 a month - almost £600 a year - as a result of the interest rate rise. Standard variable rate mortgages could see a slightly lower rise - £31 a month, around £370 a year - the organisation said.
The HomeOwners Alliance - a pressure group for homeowners and prospective buyers - urged mortgage payers to think about their current deal.
“In a world where rates are increasing monthly, we strongly recommend homeowners seek advice sooner rather than later,” said CEO Paula Higgins. “Whether you’re approaching the end of your current mortgage deal or wondering if it’s worth switching now, it’s critical to get advice.
“A mortgage broker can shop around for you, help you decide whether to make the switch, will take account of any early exit fees, and identify the best overall fit for you. And if you use a fee-free broker, you’ve nothing to lose.”
What did Bank of England say about a UK recession?
As well as announcing a hike to interest rates, the Bank of England has also given its latest outlook for the UK economy. It has updated its forecasts about the cost of living crisis and the prospects of a UK recession.
The MPC said it believes inflation will peak at a slightly lower rate than the 13% it previously predicted. It estimates that average price rises on the CPI will climb to “just under 11%” in October.
While the forecast is lower. this inflation rate would still be the highest the UK has seen since January 1982.
The reason for the lower estimate is the government’s energy bills plans for households and businesses. These energy market interventions have removed uncertainty around how much energy bills will rise this winter.
As well as a further hike to inflation, the Bank of England said it expects the UK is already in a recession. Despite previous forecasts of small financial growth in the third quarter of 2022 (July to September), the public organisation said it now expects a 0.1% fall in GDP.
Provisional estimates for the UK economy for the previous quarter (April to June) suggested a 0.2% retraction in the economy. A recession is when there are two consecutive quarters of economic shrinkage.