All eyes were trained on the Bank of England and its Monetary Policy Committee (MPC) today as it considered whether it should put interest rates up by a quarter or perhaps even half a percent.
Ultimately it decided to increase rates by 0.25 percentage points, the eleventh consecutive increase, bringing it to 4.25 per cent.
The figure the MPC eventually settles on has the power to extract more of our money from our bank accounts – a lot more.
Consider this: with the average price of a property being £289,819, according to the ONS, someone putting down a 10 per cent deposit of £28,982, would expect to pay £1,574 a month on a repayment mortgage of £260,837, with an average two-year fixed rate of 5.32 per cent.
If a 0.25 per cent interest rate rise was applied to that mortgage, taking the rate to 5.57 per cent, the repayments would jump to £1612 – a rise of £38 a month or £456 a year. For a 0.5 per cent rise that interest rate goes up to 5.82 per cent, meaning repayments would be £1,652, some £78 a month or £936 a year.
i explains why interest rates are increased – and what it has to do with inflation.
Why do interest rates go up?
So why does the MPC do it? Not to make itself popular, that’s for sure. The answer is because it feels it has to do so to tame inflation.
Inflation, the rate of increase in prices, deals a double whammy to our pockets, not only making the things we buy with our money more expensive, but also making our money worth less.
Inflation has been galloping away in the economy since 2021. It scaled a high point of 11.1 per cent in October. It has gone down somewhat since then but yesterday the economy had a nasty surprise, recording an uptick in inflation from 10.1 per cent in January to 10.4 per cent in February. Analysts had expected it to be down to 9.9 per cent.
Inflation, a pandemic-driven story?
Why did inflation start booming between 2021 and 2022? There are a number of reasons the rate of price rises jumped but one plausible theory is that during the lockdown years, many people accumulated money but didn’t have much on which to spend it.
Then, once let out of our pens, as Covid eased, we splurged all that money we had saved up.
There are, however, many other reasons that inflation has increased including the soaring cost of energy, with oil and gas in greater demand as life got back to normal after Covid. At the same time, the war in Ukraine has meant less was available from Russia, putting further pressure on prices.
Food prices have also been a huge factor, with food inflation now sitting at a 45 year high of 18.2 per cent. Costs have been pushed up as a result of vegetable and egg shortages as well as, again, the high cost of energy.
What do interest rates have to do with it?
But how does raising interest rates cool down inflation? Quite simply because we have less cash in our pockets to spend, there’s less that we can buy and that wretched cycle of more and more wads of cash, or cards being flung at goods and services, which then raise their prices slows down and prices eventually calm down.
Putting up interest rates means it is more expensive to borrow money so we borrow and then spend less of it. Think of rate rises as being like injecting the nervous, hyperactive beast of inflation with a tranquiliser.
It sounds simple and in a way it is but it’s also a pretty blunt tool for the MPC to deploy. Like a team of medics it wants to use tranquilising rate rises as sparingly as possible. The risk with interest rate rises is that like chemical coshes, they don’t just calm something down, they knock it out.