Bank of England hikes interest rate to 4.25%: base rate rise explained, how it affects mortgages and savings

The Bank of England has increased interest rates by 0.25 percentage points to 4.25% in a move it hopes will prevent further increases in the UK inflation rate.

Also known as the base rate, the UK central bank’s rate basically tells us what the price of borrowing money is across the country’s economy. The Bank uses this rate to influence inflation - an economic force which has driven the UK’s cost of living crisis over the past year.

At the last meeting of its Monetary Policy Committee in early February, the central bank’s economists opted to raise the rate by 0.5 percentage points to 4%. The latest decision means it is now at its highest rate since the depths of the 2008 financial crisis and has risen 11 consecutive times.

Interest rates have soared since December 2021 but rocketed much more rapidly in the wake of Liz Truss and Kwasi Kwarteng’s disastrous mini budget in September 2022. The biggest knock-on impact of this movement, which has also been seen in other countries, came to the surface earlier in March when Silicon Valley Bank collapsed. Consumers have also been hit by it in recent months, as the cost of monthly mortgage repayments has rocketed by hundreds of pounds.

So, what do we know about the latest interest rates decision - and what exactly is the Bank of England base rate?

What is latest interest rates decision?

Eight times a year, the Monetary Policy Committee (MPC) - a group of economists, including Bank of England governor Andrew Bailey - meets at the central bank’s headquarters on Threadneedle Street in the City of London to discuss the UK’s economy.

The MPC’s role is to look after monetary policy - i.e. everything to do with the country’s currency, Pound Sterling. They analyse the latest inflation trends and data on economic growth to set the headline bank rate, which influences how much you get charged for a mortgage or a loan.

The latest such meeting took place on Thursday (23 March) and saw the committee hike interest rates by a quarter of a percentage point to 4.25%. This rate is the highest the bank rate has been since the 2008 Financial Crisis.

Why has the interest rate gone up?

There were doubts about whether the Bank of England had finished hiking interest rates when it made its last decision at the start of February. At the time, inflation appeared to be falling, while an impending UK recession was still on the cards.

But recent events changed the picture for the central bank. Inflation grew unexpectedly in February 2023, rising from 10.1% to 10.4%. It meant the cost of living crisis that’s been hitting UK household budgets was getting worse rather than better.

At the same time, a US banking crisis begun by the collapse of Silicon Valley Bank - a demise that had been prompted by higher interest rates over the Atlantic - and the fall of Credit Suisse had created anxiety about the health of the global banking system. It meant some had urged the Bank of England not to raise its interest rate for fear it would harm the balance sheets of other banks. But, by doing so, the institution clearly believes it has the tools at its disposal to keep the financial system stable.

Explaining its decision, the Bank of England said: “The economy has been subject to a sequence of very large and overlapping shocks. Monetary policy will ensure that, as the adjustment to these shocks continues, CPI inflation will return to the 2% target sustainably in the medium term.”

The MPC said it would make a “full assessment” of recent banking woes and market volatility in its forecast in May, and that it was monitoring the situation closely. While seven of the committee’s members voted to hike the rate by 0.25 of a percentage point, two of the economists voted against a rise. Swati Dhingra and Silvana Tenreyro argued rates should remain the same as they believed some the effects of recent increases to the base rate have not yet filtered down to household level in the economy.

They were backed by Joe Nellis, professor of global economy at Cranfield School of Management, who said: "The Bank of England's decision could push the economy into a full-blown recession. Why has the Monetary Policy Committee voted to make matters worse? Households are already facing the biggest fall in their living standards for many decades, and the banking sector is under strain. Further interest rate rises will do more harm than good at this stage.

“The Bank of England must pause and wait to see if inflation plummets in the months ahead. A sharp fall is expected now that supply chain bottlenecks are easing, and the inflationary impact of Russia's invasion of Ukraine a year ago will fall away in the coming months."

ING Economics, which predicted a 0.25pp rise in advance of the rates decision, said it now expects the Bank of England to halt interest rate rises. “The Bank is keeping its options open,” it said. “Like last month, it has indicated it could hike again if inflation is continuing to show signs of ‘persistence’. Our read of that phrasing is that officials are less beholden to month-to-month swings in the data than perhaps the Federal Reserve/European Central Bank (ECB) and are trying to take a more top-level look at pricing-setting behaviour.”

Last week the ECB hiked rates for the Eurozone to 3% earlier in March, while the US central bank raised them to a maximum of 5% on Wednesday (22 March).

What does interest rates rise mean for your money?

Generally, a rise in interest rates means mortgages and credit cards will become more expensive, while savings accounts will pay out more on your money. However, any changes tend to take some time to work through the system - unless you’re on a tracker mortgage (i.e. one that goes up and down depending on the base rate).

The HomeOwners Alliance said the latest decision means anyone who is remortgaging anytime soon should “move quickly”. Its CEO Paula Higgins said: “We’re continuing to see the cheapest rates pulled from the market. The best mortgage rates on two-year and three-year fixes today are up compared to what was available at the start of March 2023. And while the best rate available on a five-year fix has nudged down compared to the start of the month, if you’re remortgaging, no one knows how long any rates on offer today will be available for.”

Forbes Advisor mortgage expert Kevin Pratt suggested he expects high street banks to remain “depressingly sluggish” with passing higher interest rates onto savings accounts. “These days, in the midst of a full-blown cost of living crisis that shows no signs of abating, those who rely on their savings for some or all or their income deserve to be treated better,” he said.

As well as affecting personal finances, the latest increase in the interest rate will hit businesses. Firms usually borrow money to fuel growth, but the latest decision means it will become more expensive to do so - something that could have an effect on economic growth.

But there was some good news from Threadneedle Street on this front. It said it expects gross domestic product (GDP) - a measure of how well the economy is performing - to increase slightly in the three months from April, reversing an earlier forecast that it would fall by 0.4%. It also forecast a better outlook for the country’s jobs market, with employment growth in the second quarter of the year likely to be stronger than expected, with unemployment set to remain flat.

Reacting to the news, Chancellor of the Exchequer Jeremy Hunt said: “With rising prices strangling growth and eroding family budgets, the sooner we grip inflation the better for everyone. That’s why we support the Bank of England’s actions today and why we will continue to play our part in this fight by being responsible with the public finances.”

But Labour’s shadow chancellor Rachel Reeves said the latest announcement would “be a source of huge concern” for households across the UK. She added: “Labour will bring the sound economic management urgently needed to stabilise the economy. Our mission to have the highest sustained growth in the G7 will get us back on track again.”

What is the Bank of England base rate?

The Bank of England looks after the UK’s currency - the pound. One of its primary roles as the UK’s central bank is to maintain the value of the currency.

Inflation essentially means the value of money is being eroded. If prices are rising and the value of money remains the same, the purchasing power of the pounds in your pocket is eaten up.

To counteract this erosion of the pound’s value, the bank sets a base rate. Very simply, this influences interest rates throughout the economy as, when it goes up, it makes money more expensive to borrow. In turn, this reduces the amount of cash flowing through the economy, with the upshot being that the pound maintains its value.

The Bank of England has a target of keeping inflation to a rate of 2% - a level which is thought to be healthy for the economy as it encourages a healthy level of spending. At 2%, you’re more likely to spend today because the product or service you want to buy could get more expensive from tomorrow.

But inflation has been rocketing for almost 18 months - reaching a high of 11.1% in October - which has forced the bank to hike interest rates in a bid to bring it down. Often, markets move ahead of the Bank of England, pre-empting changes to its base rate by looking at inflation, the state of the economy and government policy.

It means the Bank of England and the markets can influence each other. This effect was most recently seen in the wake of Liz Truss’s mini budget, which markets believed would fuel the UK’s inflation rate. They anticipated the Bank of England would hike its base rate substantially, so they put their interest rates up significantly. The central bank duly hoisted its rate by the largest amount in more than 30 years at its next MPC meeting.

Inflation has been forecast to reduce over the coming months, with the OBR predicting after the Spring Budget that it will hit 2.9% by the end of 2023. The situation has led to a softening of mortgage rates as lenders expect interest rates to fall.

Any further rises to the rate could also translate into extra economic pain for UK PLC. High interest rates make it harder for businesses to afford to borrow money, which means they will struggle to fuel growth. Put simply, high interest rates will mean it is harder for the economy to grow. But equally, high inflation is also bad for business given price rises can put consumers off spending. So the UK central bank will also be walking a tightrope between these considerations on 23 March.

Additional reporting by PA