Bank of England set to hike interest rates to 1% to rein in inflation

·7-min read
A person walks past the Bank of England in the City of London financial district in London, Britain, January 23, 2022. REUTERS/Henry Nicholls
The Bank of England is poised to take the base rate to its highest in 13 years. Photo:Henry Nicholls/Reuters

The Bank of England is poised to raise interest rates to their highest level in 13 years as it seeks to cool inflation.

The BoE’s monetary policy committee (MPC) meets on Thursday and is expected to increase interest rates by 0.25%, taking the central bank’s base rate to 1% – its highest level since early 2009.

Members of the MPC have already raised rates at each of its past three meetings to try to rein in inflation, which hit a 30-year high of 7% in March.

“We expect the Bank of England to push ahead with its tightening bias on Thursday, hiking by +25bps, given initial conditions of high inflation, rising inflation expectations, and a tight labour market, “ Peder Beck-Friis, portfolio manager at PIMCO, said.

“The message will likely be unchanged: hike now — likely more in the future — to stop second-round inflation effects,” he added.

Analysts were previously estimating a half percentage point rise to 1.25% but the consensus now is that the central bank will move more cautiously as UK households are squeezed by inflation.

“Our view is that the Bank of England is having to thread the eye of a needle when it comes to tackling the current inflation surge such that it doesn’t induce a recession, meaning that relevant caution is required,” Simon Harvey, head of FX analysis at Monex Europe, said.

Read more: Bank of England may slow interest rate rise as Bailey warns of UK recession

“Therefore, we don’t think the BoE will conduct a 50bp hike at any of its remaining meetings this year unless there is substantial evidence showing wage growth is responding to rising price pressures.”

The BoE is in an exceptionally tricky position as it seeks to rein in soaring inflation without pushing the economy into a recession.

“UK inflation continues to run at a high level, so we should expect further rate hikes later in the year, with 25 basis point moves still the most likely course of action,” Chris Beauchamp, chief market analyst at IG, said.

“While this means the pound will remain under pressure vis-à-vis the US dollar, it allows the bank to proceed with its hiking policy without putting too much pressure on the economy, which remains in a weaker position than its US counterpart.”

Deutsche Bank also said a 50bps hike this year is unlikely as the central bank tries to avoid exacerbating slower economic growth.

“Can the BoE surprise with a 50bps hike at some point this year? The short answer: it’s a long shot,” Sanjay Raja, chief UK economist at Deutsche Bank, said.

Harvey is expecting a 1-6-2 vote split amid concerns around growth conditions.

“We expect the Bank of England to hike rates by 25 basis points, bringing the Bank rate to 1%. Based upon inter-meeting communications, we believe Jon Cunliffe will maintain his dovish stance, opting to hold rates, and two of the four members who voted for a 50bp hike in February (Haskel, Mann, Ramsden and Saunders) to do so again in May.

“This would result in a 1-6-2 vote split. Compounded by increasingly cautious language in the policy statement, repeated concerns around growth conditions and consumer sentiment in the meeting minutes, and the market-implied forecasts in the Monetary Policy Report showing a substantial deterioration in the UK’s economic outlook, we expect the BoE’s decision to be viewed as a 'dovish hike'."

Investec is pencilling in another rate hike in August to 1.25%.

How will the possible hike affect you?

Around 2 million households could see monthly payments rise after Thursday's decision.

The Bank of England’s interest rate sets the level of interest all other banks charge borrowers. This base rate impacts other interest rates, including the mortgage base rate.

If interest rate goes up, payments on a variable-rate mortgage will increase. This is typically a tracker that follows the base rate, or a loan on a lender’s standard variable rate.

Across the UK around 850,000 properties are on tracker mortgages, which directly follow the Bank of England base rate, while 1.1 million are on standard variable rates which follow a rate set by the lender, which usually closely follows the BoE’s interest rate.

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According to credit app TotallyMoney, a rise of 1% above the 0.1% at which base rate was sitting for most of 2021, would increase mortgage payments by £99 per month or £1,188 per year for a 75% loan-to-value (LTV) mortgage on the average UK property costing £270,708.

A row of houses are seen in London, Britain June 3, 2015. British house prices rose at their slowest annual rate in nearly two years in May, as growth continued to moderate after double-digit increases in the middle of 2014, figures from mortgage lender Nationwide showed on Wednesday. REUTERS/Suzanne Plunkett
Around 2 million households could see monthly payments rise after Thursday's decision. Photo:Suzanne Plunkett/Reuters

In London, the research revealed, this increases to £191 per month or £2,292 per year for a 75% LTV mortgage on the average London property costing £519,934.

Those in the South East with an average property price of £369,093 would see annual costs rise £1,620 on the same terms.

In the North East with an average price of £149,249 a 75% LTV mortgage would cost an extra £648 a year.

TotallyMoney's analysis found one in four mortgage customers currently had no protection against interest rate increases and were already facing higher payments.

Alastair Douglas, CEO of TotallyMoney, said: “As the Bank of England increases the base rate to ease inflationary pressures, the two million homes on variable-rate and tracker mortgages will see their household finances squeezed even more.

“And the situation isn’t going to get much better for those nearing the end of their current deals. They have a choice of facing the more expensive SVR or having to switch to a new, and more expensive fixed-rate product.”

He added: “Customers feeling the squeeze from the increased cost of living should consider cutting back on using expensive credit lines such as overdrafts, and move interest-bearing credit card balances to a 0% offer.

“By reducing the interest being paid, customers can repay their debts quicker, or use the money saved to cover other costs.”

Homeowners on fixed-rate deals, will not feel the effects until their fixed term ends and they’re moved across to their lender’s standard variable rate (SVR).

A higher base rate, however, is good news for savers, who will earn better returns.

Leap in the dark

Increasing rates from 0.75% to 1% means the BoE hits a self-imposed threshold to reveal next steps in its programme of bond buying, known as quantitative easing.

Plans sell off some of its £847bn in government bond holdings will take the central bank into unchartered territory. No other major economy has taken the step to sell government bonds accumulated under quantitative easing since 2008.

Read more: ECB confirms end of bond buying as it leaves rates unchanged

“The MPC has already said that it will stop reinvesting the proceeds of its bond purchases, but a move to outright selling is still viewed as potentially disruptive, so a tentative timetable may be all we get this time around,” IG’s Beauchamp said.

Monex Europe’s Harvey also does not expect the central bank to show all its cards.

“With the Bank Rate lifted to 1%, the Bank of England will also start to consider ‘beginning the process of actively selling assets,’ but we don’t think that now is the opportune time for the BoE to lay out its plans for active quantitative tightening given current levels of uncertainty around its impact and the elevated volatility in bond markets at present,” he said.

As households and businesses tighten their belts in the face of the cost pressures, UK growth is set to suffer and the Bank is likely to trim its outlook for the economy as well on Thursday, according to experts.

Investec economists said: “The UK is in the grip of the cost-of-living crisis. Coupled with tax rises, this leaves a rocky road ahead.”

They expect that a recession will be avoided, thanks in large part to the savings built up by households in the pandemic, but said slowing growth and soaring inflation “leaves the MPC in a bind”.

BoE’s governor Andrew Bailey has stressed the central bank will move carefully and not sell in times of fragility in financial markets.

The Bank of England will officially announce its decision after 12h00 on Thursday.

Watch: How does inflation affect interest rates?