UK interest rate rises to 4.5%: Bank of England base rate explained - what it means for mortgages and savings

The Bank of England has hiked UK interest rates for a 12th consecutive time today (11 May) as it bids to tackle soaring inflation.

It has been increased by 0.25 percentage points to 4.5% - a fresh 14-year high. Although headline inflation fell back in March 2023, the rate of price hikes continues to remain close to record levels. Indeed, the UK’s Consumer Prices Index (CPI) is now an outlier among the major western economies.

Food prices have kept the rate of price rises elevated - although falling petrol and diesel costs have been enough to pull down the overall rate marginally. Meanwhile, core inflation - the statistic that the UK central bank watches closely - remains relatively unchanged. It all means the cost of living crisis is still very much with us, as high inflation rapidly erodes our spending power.

The Bank of England uses its interest rate (also known as the base rate) to control inflation. It has hiked the rate from 0.1% in December 2021 to 4.25% in March 2023. These increases have piled hundreds of pounds onto mortgage bills while also boosting savings rates - albeit not at a rate that can compete with inflation. Today’s expected increase could be the last we see in 2023, but economic uncertainty has made predictions difficult.

So, what do we know about the UK central bank’s interest rate decision - and what will it mean for your money?

What is the UK interest rate?

The new UK interest rate is 4.5% having been hiked by 0.25 percentage points in May 2023. It is now at its highest level since October 2008, when the Bank of England was lowering the base rate in a bid to stave off a recession.

It means interest rates are much higher than they were during the 2010s when they were consistently kept below 1%. During the Covid pandemic, they were left as low as 0.1%.

The rate is set eight times a year by the Bank of England’s Monetary Policy Committee (MPC) - a group of nine economists, four of whom are independent from the UK central bank. They take into account the UK’s economic picture before opting to reduce, freeze or hike interest rates.

A way to understand interest rates is that they are like a car brake, while inflation is the accelerator. If demand in the economy is accelerating at a rate that supply cannot keep up with, as it currently is, price rises can occur so rapidly that we struggle to afford the basics (something we are seeing with the cost of living crisis). But the Bank of England can apply the brakes by using its interest rate to slow the economy down to a more manageable level.

By increasing the base rate, the cost of borrowing money becomes more expensive - something that translates into higher mortgage costs and better savings interest rates. The upshot of doing this is that demand tends to fall across the economy as people and businesses cannot afford to borrow as much, and turn to saving over spending.

This activity can cool down the rate of price rises. But the downside is that using this brake too aggressively can stop businesses from growing, as they tend to borrow money to fuel expansion and invest in their existing operations.

Why have interest rates gone up?

The Bank of England MPC met on Wednesday (10 May), with the outcome of this meeting revealed at midday today (11 May).

The central bank’s primary goal at the moment is to cut inflation. The rate of the CPI is currently 10.1% as of March 2023. While this amounted to a drop in the rate of price rises, economists had hoped it would decline into single figures. The fact it remains just a percentage point below October 2022’s record high of 11.1% meant another rate rise was almost nailed on from when this data came out in April.

Explaining its decision, the bank said it believes there is a possibility that inflation in wages and daily costs “may take longer to unwind than they did to emerge”. By raising its base rate, it hopes to “address the risk of more persistent strength” (in other words, the stickiness) of these inflationary pressures.

It also pointed to better than expected economic activity - although this uplift has meant demand in the economy is likely to be “materially stronger” than previously predicted, which could keep inflation high. While the economy remains stagnant, with no GDP growth expected over the first half of 2023 according to the Bank of England’s predictions, the fact it hasn’t declined as anticipated in its previous forecasts means the central bank feels it can still hike its base rate without casuing too much damage.

Before the rate increase, independent research firm Capital Economics - which had long-predicted a hike to 4.5% - pointed out that “interest rate sensitive areas”, like car sales, construction and manufacturing, saw an improved performance over the first quarter of the year compared to the last quarter of 2022. It suggested there was room for the Bank of England to ratchet up interest rates further.

Meanwhile, employment figures released by the Office for National Statistics (ONS) on 18 April showed private sector wage increases of 6.6% in the three months to February - a 3.4% real-terms decrease when inflation is taken into account. Vacancies also fell back slightly - the more roles that need filling across the economy, the more wages are likely to be pushed higher - something that can increase inflation.

Economists reckon this could be a sign of sticky inflation, as greater spending power could mean demand remains higher. Governor Andrew Bailey has previously warned above-inflation salary increases could keep higher interest rates in place for longer.

Another likely factor in its decision is that the US and EU central banks both hiked their interest rates in May. Their decisions tend to influence the Bank of England as they can impact on the value of the pound compared to the dollar and euro.

What does interest rate rise mean for your money?

Given the major cost of living crisis the UK faces, anything that could add to the squeeze on household budgets is going to be an unwelcome thing for everyone. Here is how the latest decision could impact your finances:

• Mortgage rates

Interest rates have a big influence on mortgage rates, although lenders and markets also take other things into account, like bond yields and a potential borrower’s credit history. But they are especially important for those on tracker mortgages (i.e. deals that follow the Bank of England base rate and add a percentage on top) and standard variable rate (SVR) mortgages, with an estimated 1.4 million households sitting on such rates.

The last base rate decision, which saw the base rate climb 0.25 percentage points to 4.25%, added amore than £280 to tracker repayments and £180 a year to SVR mortgage servicing. Mortgage bills for these products are now respectively around £3,000 and £4,750 higher than they were in December 2021 when interest rates started climbing.

For most mortgage payers, today’s announcement will not change much. Those on fixed deals will probably not see a rate increase, while the markets are likely to have factored the Bank of England’s next decision into their pricing for those who are remortgaging or seeking out a fix.

But experts warn those coming off longer-term fixes dating from when interest rates were under 1% are likely to face a shock when they come to remortgage. “Those coming off a cheap fixed-rate mortgage may be in for a shock; fixed mortgage rates average 5.28% for two year deals and 5% for five-year deals,” says HomeOwners Alliance CEO Paula Higgins.

“A major side-effect of these continual rate rises is that a lot of homeowners will just assume staying put on their current deal must be better than paying 5%. But if you're on your lender’s standard variable rate, you could be paying significantly higher rates than this. In many cases SVRs are already around 8%, even before this latest increase. So we're calling on homeowners to please pull out your paperwork and check what deal you're on and what rate you're paying. Because you could be saving hundreds every month.”

NationalWorld recommends speaking to an insurance broker to get the best advice on what to do if you’re seeking out a new mortgage. They may also have access to cheaper deals than those available on the open market.

• Savings rates

In theory, savings rates should get a boost from a higher base rate. As with mortgages, they should already have risen in advance of the latest rates announcement. But in practice, there has been a major lag between the Bank of England’s announcements and uplifts in what savers are getting for their money (although, these increases are currently well below the rate of inflation).

Indeed, banks have been repeatedly criticised by MPs and campaigners for not passing on interest rates quickly enough. On Wednesday (10 May), chair of the Treasury Committee Harriet Baldwin said: “In a high interest rate environment, and with further Bank of England base rate rises possible, banks must do more to encourage saving. Consumers should continue to vote with their feet and find better offerings.”

Writing in his weekly Money Tips newsletter, Money Saving Expert Martin Lewis echoed Baldwin’s words by urging the milions of consumers who are getting rates of just 1% to switch to better accounts. He said some fixed deals are now close to the 5% mark, while easy-access accounts are now close to 4%.

Meanwhile, Laura Suter - the head of personal finance at AJ Bell - has pointed out that most people are unlikely to be able to benefit much from higher savings rates anyway, given many of us have “dipped into, or entirely pillaged, our savings” in a bid to tread water amid the cost of living crisis.

• Debt

If you’re in debt, the latest Bank of England decision could result in higher fees to pay it off. As we have seen with mortgages, loans of all stripes are influenced by interest rates.

If you are struggling to pay off your debts, NationalWorld recommends speaking to your lenders to see if you can get breathing space. You can also contact StepChange and the National Debtline for free advice.

• Wages

Wages have failed to keep up with rocketing inflation - a situation that has led to considerable unrest amongst workers across the economy. By hiking the base rate again, progressive think tank the IPPR has warned the Bank of England risks increasing inequality.

“The Bank of England should have held off raising rates,” its senior economist Carsten Jung said. “The current approach risks creating big economic costs, in the form of lower future growth and fewer jobs, while not actually being effective enough at bringing down inflation. There will be a continued increase in inequality as a result of this: many on low incomes, who are already the ones whose wages are least keeping up with inflation, are the ones hardest hit by lower growth caused by further rate increases. Meanwhile many firms are comfortably keeping up their profit margins.”

Mr Jung called for a more “balanced” approach from both the central bank and the government to address sticky inflation. He argued that extra energy bills and income support would help reduce inflation, while tougher windfall taxes would “disincentivize excessive price increases”.