The Bank of England has increased base rate 0.5 percentage points to 5 per cent in the latest move by the Monetary Policy Committee to tackle stubbornly high inflation.
The decision marks the bank’s 13th base rate hike since December 2021, resulting in the sharpest rise since 1989 – a jump of 4.9 percentage points over 18 months.
Base rate is at its highest level since April 2008 when it also stood at 5 per cent.
The MPC voted by a majority of 7–2 to increase Bank Rate by 0.5 percentage points, to 5 per cent. Two members preferred to maintain Bank Rate at 4.5 per cent.
Stubborn inflation has sent expectations of how high base rate will need to go soaring and triggered mayhem in the mortgage market, with rates soaring over the past month.
It has been better news for savers, however, who have also seen rates on the top savings deals rise rapidly.
We explain why the Bank of England is continuing to raise interest rates and what it means for your mortgage, savings and the wider economy.
Up again: The Bank of England has raised its base rate for the 13th consecutive time since 2021
Why are interest rates still rising?
Interest rates are still rising due to stubborn inflation.
The official consumer prices index measure of inflation (CPI) stuck at 8.7 per cent in May, unchanged from April, according to the Office for National Statistics.
Meanwhile, core inflation – the underlying figure that strips out volatile food and energy prices, is continuing to rise.
Today’s rate rise is not unexpected. Stubborn inflation figures – driven by high food, flight and gas prices – left the Bank with little option but to push up its rate, ending hopes from spring that hikes would have ended by the second half of the year.
Inflation has remained high forcing the bank to use the only real tool in its arsenal to try and bring it down – raising interest rates.
The Bank of England is raising what is officially known as bank rate but more commonly called base rate to try to tame inflation.
The theory is that this raises the cost of borrowing for individuals and businesses and thus reduces demand for it, slowing the flow of new money into the economy and slamming on the brakes.
The MPC sets interest rates to try to keep inflation at the Bank and Government’s 2 per cent target.
Over the past 18 months, inflation has soared well past that – peaking in double-digits. Although it has since fallen, it has not come down as much as expected, leading markets to expect the Bank will need to impose more rate hikes to rein it in.
Base rate is now forecast to peak at just below 6 per cent.
May’s inflation figures ended any speculation that June’s rate rise would be the last in the cycle and the debate is now open again as to when inflation will fall far enough for the rate hikes to end.
Heating up: Core inflation prices are at a 30-year high, meaning more base rate hikes are likely
Andrew Goodwin, chief economist at Oxford Economics, told This is Money we are into a phase of inflation driven predominantly by strong wage growth.
Companies are passing higher wage costs on to consumers, he says, something the Bank has been worried about for a while.
It is a scenario that suggests inflation – and subsequently interest rates – will be higher for longer.
‘The Bank is likely to raise rates a couple more times and there is a real risk it goes too far and causes a recession but it almost has to go far before it gets sorted’, he adds.
Higher base rate has created a mortgage crisis for some – especially those who are due to remortgage in the near future.
That’s because home loan rates are rising. They had cooled a little in the first few months of 2023 after rises were triggered by the mini-Budget in September last year, as the market baulked at then Prime Minister Liz Truss’ list of unfunded tax cuts.
The Bank of England has hiked its base rate to 5%, the highest level since 2008
Forecasts this would lead base rate to rise much more than previously forecast sent mortgage rates spiralling last autumn.
But the latest inflation-induced mortgage panic has sent rates on new home loans back up towards those levels again.
Conditions now are trickier than back in October says Geoff Yu, strategist at BNY Mellon, argues.
He said: ‘As opposed to the mini-Budget “crisis” of last autumn, there is no supposedly “radical” administration to remove, which could help “un-spook” markets.
‘This time the fears for the economy are patently structural, and with them come the expectations that a hard landing is the only form of mitigation.’
However, the successive interest rate rises have been good news for savers. Savings accounts now offer some of the highest interest rates in recent years. In theory this encourages people to save more and spend less, pushing down inflation by slowing the economy.
But it also means slower economic growth and now recession fears.
Rob Morgan, chief investment analyst at Charles Stanley, said: ‘Price pressures continue to linger with the core reading. This suggests inflation is more entrenched than anticipated, with food and energy price inflation failing to recede enough to have much of an impact.
‘The only crumbs of comfort for the Bank of England came from producer or factory gate prices, which rose by 2.9 per cent in the year to May 2023, down from 5.2 per cent in April. This indicates pressure is easing further up the supply chain and may start to percolate down.
‘In the financial markets, bond markets have already sensed the oppressive inevitability of the UK’s inflation problem, which is making life tough for household finances already straining under the combined weight of food and energy costs.’
Will mortgage rates go up?
Whether or not your mortgage rate will go up may depend on the type of loan you have.
While tracker and variable rates are likely to move in response to the raise, fixed rates are less certain as some brokers believe lenders have already priced in the increased cost.
The typical cost of new fixed-rate mortgages has been pushed up over the past 12 months, despite the cost not being directly linked to the base rate.
The average two-year fixed mortgage rate is now 6.19 per cent, according to Moneyfacts. The average five-year fix is 5.82 per cent.
At the start of the month the average rates were 5.49 per cent and 5.17 per cent, respectively. These are up from 2.59 per cent and 2.82 per cent last year.
For the 1.4 million people who need to remortgage this year, the price increases are likely to have a serious hit on their finances, particularly for the three in five whose rates are currently below 2 per cent according to the ONS.
The average borrower coming off a two-year fix will see their rate increase from 2.55 per cent to 6.19 per cent.
On a £200,000 mortgage over a term of 25 years this means monthly mortgage payments rising from £902 to £1,312 – an increase of £410 a month or £4,920 a year.
Fixed-rate mortgages are the most popular choice for homeowners, with around three quarters of borrowers opting for the term. But around a quarter of mortgages are on variable deals.
Rates on the up: Mortgage rates have been rising after a period of slow decline
Variable rate mortgages include tracker rates, ‘discount’ rates and also standard variable rates. Monthly payments on all these types of loan can go up or down.
Trackers follow the Bank of England’s base rate plus or minus a set percentage, ie base rate plus 0.5 per cent.
Standard variable rates are lenders’ default rates that people tend to move on to if their fixed or other deal period ends and they do not remortgage on to a new deal.
These can be changed by lenders at any time and will usually rise when base rate does, but they can go up by more or less than the Bank of England’s move.
If you are on a standard variable rate it could be worth speaking to your lender or broker to see if they can reduce your costs via through a better deal.
Discount rates are deals that track the bank or building society’s standard variable rate rather than the base rate. If the SVR changes, so will these.
Mortgage holders on a base rate tracker product will see their payments increase to reflect the Bank of England rise.
> How do rising rates affect you? Use our True Cost Mortgage Calculator
Some announce immediately, some wait to tell borrowers. However, most will likely see rates edge up over the coming weeks.
Although fixed mortgage rates are not directly tied to the base rate, lenders will often pass on the increased price of borrowing to consumers.
How high will fixed rate mortgages go?
Higher than anticipated inflation figures at the end of May increased the chance of further base rate rises.
In response to heightened base rate expectations, both gilt yields (the rate on UK government borrowing) and swap rates – the money market rates that lenders use to set fixed rate mortgage pricing – have increased substantially.
Five-year swaps are currently at around 4.87 per cent. On 22 May they were around 4.17 per cent. Similarly the two-year swap rate is now around 5.57 per cent, up from 4.63 per cent in May.
Swap rates – the main pricing mechanism for fixed rate mortgages – are nearly back to the same levels as after the mini-budget.
Since thenm borrowers and brokers have battled successive rate rises and the average two-year fixed rate tipped over 6 per cent on Monday for the first time since December.
Andrew Wishart, senior property economist at Capital Economics, said: ‘Our view that mortgage rates will peak at 5.75 per cent may still be too low, with a rise to over 6 per cent for the first time since before the financial crisis now a strong possibility.’
If home loans remain at these prices for several years the economics consultancy firm believes house prices may fall by as much as 25 per cent as a result.
‘Two thirds of borrowers have not yet refinanced since mortgage rates started to rise, so most of the effect of higher mortgage rates on household finances is yet to be felt,’ adds Wishart.
Nicholas Mendes, mortgage technical manager at John Charcoal, says: ‘Ultimately this isn’t good news for mortgage holders currently on a variable rate or approaching their final year of their fixed rate deal likely to be sub 2 per cent.
‘I expect markets will now be pricing in a base rate peak of 6 per cent to 6.25 per cent, a substantial difference from a few months ago when this was 4.75 per cent.’
What does the base rate rise mean for savings?
Some banks have seemingly pre-empted the Bank of England’s decision today having already upped their savings rates over the past few days, but expect plenty of other providers to follow suit now the announcement has been made.
That said, some of the big banks still pay 1 per cent or less on their standard easy-access deals, while plenty of people keep large amounts of money in their bank accounts, often earning absolutely nothing.
Some banks and building societies have used rising rates to improve their margins and profits meaning they haven’t passed on the full benefit of the successive rises as an investigation by This is Money uncovered earlier this year.
There is therefore no guarantee that your bank or savings provider will hike their rates in response to the base rate.
So the advice is simple. Don’t be loyal to your bank or savings provider. Be proactive and hunt for the best rates using our independent best buy savings tables.
Heading higher: Savings rates have been climbing at speed in recent weeks with banks battling each other in order to take top spot and attract customers.
Rachel Springall, finance expert at Moneyfacts, says: ‘A flurry of savings rate competition and consecutive Bank of England base rate rises continue to improve the savings market.
‘Those savers earning variable rates of interest who take time to review their existing pots may find more attractive returns are available elsewhere, as their loyalty has not been rewarded.
‘The top easy access accounts pay around 4 per cent, with the market average around 2 per cent, however, some of the biggest banks pay much less.
‘Shopping around for a better deal is imperative in a volatile interest rate environment, so keeping an eye on the top rate tables and signing up to newsletters is wise.
‘Challenger banks and building societies continue to offer some of the top returns and have the same deposit protections in place as the more familiar high street banks, so there is little reason to overlook them in favour of a well-known brand.’
Top of the market: Savers should be looking at best buy tables to locate the best rates on the market.
How high will the best savings rates go?
The best savings rates have been climbing at speed in recent weeks with banks battling each other in order to take top spot and attract customers.
The average easy-access savings rate has increased by 0.78 percentage points from 1.56 per cent to 2.34 per cent since the start of the year, according to Moneyfacts.
During that same time the Bank of England has upped the base rate from 3.5 per cent since January.
The average one-year fixed rate deal has risen by 0.93 percentage points since the start of the year, rising from 3.56 per cent to 4.49 per cent, according to Moneyfacts.
Anyone keeping a keen eye on This is Money’s best-buy savings rates tables will have noticed major improvements.
The best easy-access rate now pays 4.11 per cent up from 3 per cent in January. At the same time the best one-year fix pays 5.7 per cent, up from 4.25 per cent.
Markets now expect that the Bank of England will raise the base rate to 5.75 per cent later this year. Some traders are even betting on it getting to 6 per cent.
Rainy day fund: Most personal finance experts believe that this should cover between three to six months worth of basic living expenses.
Kevin Mountford, founder of the savings platform, Raisin UK, believes that if things remain on the current trajectory it may not be long before we see a 6 per cent deal.
‘Today does come as great news for savers, he said. ‘Fixed-rate bonds have seen record increases in the past four months, especially in the one-year space.
‘This could lead to 6 per cent accounts finally making a return – last seen in November 2008.
Andrew Hagger, a personal finance expert at MoneyComms adds: ‘If the base rate reaches either 5.75 per cent or 6 per cent as many are predicting then we may even see a 5 per cent easy-access savings rates.’
Which banks offer the best savings rates?
When it comes to choosing an account. It’s always worth keeping some money in an easy-access account to fall back on as and when required.
Most personal finance experts believe that this should cover between three to six months worth of basic living expenses.
The best easy-access deals, without any restrictions, all pay north of 3.75 per cent. If you’re getting anything less than this at the moment, then switch to a provider that will do.
In terms of the best of the best, Oxbury Bank is now offering a market leading easy-access deal paying 4.11 per cent.
Someone putting £10,000 in Oxbury’s account could expect to earn £411 of interest over the course of a year – albeit if the variable interest rate remains the same.
– Check out the best easy-access savings rates here.
Those with extra cash which they won’t immediately need over the next year or two, should consider fixed rate savings.
Fixed rates offer the best returns at present. The best one-year deal is available via the savings platform Raisin UK, and is being offered by Ahli United Bank.
It is Financial Services Compensation Scheme protected, meaning saver deposits are protected up to £85,000 per person.
Someone putting £10,000 in Ahli United Bank’s deal will earn a guaranteed £570 interest over one year.
– Check out the best fixed rate savings deals here.
Savers should also consider using a cash Isa to protect the interest they earn from being taxed.
Virgin Money is offering a one-year fix paying 4.75 per cent, a two-year deal paying 4.91 per cent and a three year fix paying 5 per cent.
Savers can also opt for Shawbrook Bank’s easy-access account paying 3.78 per cent.
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