What does ‘interest rate rise’ mean? Bank of England rates increase explained - savings and mortgages impact

Pressure mounts on Bank of England after inflation reaches 10 year high, exceeding 5%

Governor of the Bank of England Andrew Bailey. (Pic: Getty)

Interest rates have been a hot topic of late.

Soaring rates of inflation, with the latest ONS figures showing the figure exceeding 5%, has put pressure on the Bank of England to act.

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Here’s what we know about the change to interest rates and what it could mean for mortgages.

Have interest rates gone up?

The Bank of England has increased the interest rate to 0.25%, in a bid to rein in rising inflation.

It is the first rate increase since August 2018 and only the third since the financial crisis, as the Bank commits to being the first major institution to raise rates since the pandemic hit.

The Bank’s Monetary Policy Committee (MPC) voted eight to one to raise rates, after figures showed that inflation had risen for the fourth month in a row and to the highest point in a decade.

"Most members of the committee judged that an immediate, small increase in Bank rate was warranted," said the Bank on the news, adding that the decision was "finely balanced".

What does interest rate rise mean?

An increase to the interest rate effectively means it will cost more to borrow money from lenders, and could encourage people to save money rather than spend it.

Since March 2020 the interest rate has been 0.1% as the Bank of England propped up the economy, urging people with money to spend it rather than lose out saving.

If inflation exceeds interest rates then currency depreciates, meaning the money you have and earn doesn’t stretch as far when it comes to paying for everyday goods and services.

When interest rates are higher it encourages people to save money, to see a greater return on their investments, but also means it will cost more to borrow money, such as with a mortgage.

How does the interest rate affect mortgages?

The interest rate can have a big impact on how much you pay back on your mortgage.

This is because if the interest rate increases, the base rate at which lenders charge you to borrow money also increases, which can lead to a higher monthly mortgage payment.

Those on a variable rate mortgage will feel the impact as the monthly payment can change immediately if there is a change to interest rates, either up or down.

Yet fixed rate mortgages will be locked in for the duration of the agreement, often advertised between two, three or five years. There might be a big jump at the time of renewing, however.

Has the surge in Covid cases impacted interest rates?

Increasing the interest rate raised some eyebrows in the finance sector, as the highly transmissible Omicron variant behind a surge in Covid cases.

But the Bank of England has decided to act in a bid to bring the rising cost of living under control, though inflation is still expected to peak at 6% in early 2022.

It said there was "some value" in waiting for more information around Omicron and how likely it was to "escape the protection of current vaccines and on the initial economic effects of this new wave".

The Bank added: "There was, however, also a strong case for tightening monetary policy now, given the strength of current underlying inflationary pressures and in order to maintain price stability in the medium term."

Reaction to interest rates rise

The British Chambers of Commerce (BCC) called the Bank’s decision to hike interest rates “surprising” in light of the sharp rise of Covid cases.

Alpesh Paleja, lead economist at the CBI business group, said: "The decision to raise interest rates signals that the MPC wants to get off on the front foot in tackling rising inflation."

But he added that policymakers may move more cautiously in raising rates further "if there are strong signs of either the virus or Plan B restrictions dampening activity and price pressures".

Head of Corporate Partnerships at Sirius Property Finance, Kimberley Gates, said any increase in interest rates "is always going to cause concern from homeowners who will be understandably worried about the implications it might have on their monthly mortgage payments".

"However, it’s important to remember that even with today’s increase, rates remain incredibly low and so there’s certainly no reason to run for the hills.

"Stress testing will have ensured that any monthly cost increase is easily stomached by the nation’s homebuyers and many more will have also locked in fixed-rate terms which they will continue to benefit from.

"While there will no doubt be some reaction by lenders in line with today’s increase, it’s unlikely to dampen our appetite for homeownership and buyers will continue to benefit from some of the lowest rates seen in recent times," she added.

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