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Bank of England interest rates: How high will they go?

By Ryan Hogg

Edited by Jekaterina Drozdovica


Updated

The Bank of England Museum, located within the Bank of England in the City of London
The Bank of England raised its key interest rate to 3% in early November 2022 – Photo: William Barton / Shutterstock.com

The Bank of England (BoE) raised interest rates by 50 basis points (bps) in its December meeting, taking the rate to a new 14-year high of 3.5%. The rise has matched the increase implemented by the US Federal Reserve (Fed) in its recent decision.

According to the December Monetary Policy Summary published by BoE, the 12-month CPI inflation fell from 11.1% in October to 10.7% in November. The November figure was slightly below expectations at the time of the last report. 

According to the report, CPI inflation is expected to continue to fall gradually over the first quarter of 2023, as earlier increases in energy and other goods prices drop out of the annual comparison.

What are interest rates and how does the BoE set them?

The Bank of England is the UK’s central bank. It oversees the country’s monetary policy and has been independent since 1997. 

It has the power to set the key interest rate, which filters down to UK banks’ interest rates – including the lending and savings rates offered by high street banks and building societies. The Bank can also print money to stimulate the economy through quantitative easing.

The Bank’s Monetary Policy Committee (MPC), made up of economists and run by Bank of England Governor Andrew Bailey, makes monetary policy decisions at meetings eight times a year. The next meeting is scheduled for 2 February 2023.

BoE’s monetary policy over the years

The Bank of England interest rate, or bank rate, has been at historic lows since the onset of the global financial crisis of 2008, which triggered a deep recession in the UK. 

British interest rates fell from 5.75% in July 2007 to 0.5% by January 2009 as the Bank of England sought to support jobs and income with lower rates, while also trying to stoke demand after a housing market crash.

The BoE’s interest rates hovered at that level for seven years as the country struggled to pull itself out of the downturn amid austerity policies implemented by the then Conservative-Liberal Democrat coalition government.

The Brexit vote of June 2016 inspired a further cut to UK interest rates to 0.25% to fend off the effects of a falling pound and negative investor sentiment. But, as confidence returned and some clarity about Brexit began to emerge, the bank started to slowly tighten its policy, raising rates to 0.75% by August 2018. 

Graph of Bank of England's interest rates over 25 years

Any further progression of rates in preparation for a slowing business cycle went out the window with the onset of the Covid-19 pandemic. The crisis saw the unusual combination of both expansionary monetary and fiscal policy as the UK government supported jobs and incomes during lockdowns. The BoE took the bank rate down to an all-time low of 0.1% in March 2020. 

Now a period of high inflation is causing the BoE to accelerate its schedule of rate rises. In its 4 August meeting, the Bank of England raised interest rates by 0.5% to 1.75%, followed by another 0.5% on 22 September, hiking further still on 4 November, lifting the bank rate to 3%. As of the December meeting, the bank rate stands at 3.5% – the highest level since 2008.

What’s driving price rises?

Inflation continues to hit 40-year highs in the UK, with the Consumer Prices Index (CPI) rising to 10.7% in the 12 months leading up to November, according to the Office of National Statistics. On a monthly basis, CPI rose by 0.4% in November 2022, compared with a rise of 0.7% in November 2021.

Housing and household services (primarily electricity, gas, and other fuels) and food and transport costs (primarily motor fuels) were the biggest contributors to inflation.

The UK is dealing with wider macroeconomic issues of tight supply and pent-up demand following loosening pandemic restrictions, together with macroeconomic uncertainty resulting from Russia’s invasion of Ukraine.

But the nature of price rises has weighed on the decision-making of the BoE’s Monetary Policy Committee. 

“Another larger-than-expected increase in inflation is turning up the heat on the UK’s economy – and on the spending power of the nation,” said Laura Suter, head of personal finance at AJ Bell.

Suter highlighted that the situation is not a new one, as petrol, home energy bills, food prices and mortgage costs have been pushing up the inflation rate in previous months, too. 

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“This highlights the Bank’s conundrum, as one of the biggest contributors to inflation at the moment is mortgage costs, which are a direct result of the rate setters increasing Base Rate significantly since December.”

Rising interest rates in banking are pushing up mortgage rates and continue to be a significant contributor to inflation. This may be an issue for the BoE, which will be forced to contend with the fact that raising UK interest rates speeds up inflation. 

Jobs market

While the economic circumstances are unlike anything the BoE has observed since gaining independence, it will still look to some classic indicators to gauge how hot the economy is running.

The latest labour market report by the Office for National Statistics (ONS) sent mixed signals to policymakers.

“The UK employment rate for August to October 2022 increased by 0.2 percentage points on the quarter to 75.6% but is still below pre-coronavirus (Covid-19) pandemic levels. Over the latest three-month period, the number of employees increased, while self-employed workers decreased,” the report stated.

“In September to November 2022, the estimated number of vacancies fell by 65,000 on the quarter to 1,187,000. Despite five consecutive quarterly falls, the number of vacancies remains at historically high levels. The fall in the number of vacancies reflects uncertainty across industries, as respondents continue to cite economic pressures as a factor in holding back on recruitment.”

The document goes on: “In real terms (adjusted for inflation) over the year, total and regular pay both fell by 2.7%; this is slightly smaller than the record fall in real regular pay we saw in April to June 2022 (3.0%) but still remains among the largest falls in growth since comparable records began in 2001.”

Action by other central banks

The euro area annual inflation rate was 10.6% in October 2022, up from 9.9% in September. A year earlier, the rate was 4.1%. European Union annual inflation was 11.5% in October 2022, up from 10.9% in September.

After eurozone inflation hit 8.6% in June, the bloc’s Monetary Policy Committee at the European Central Bank instigated a 0.5 percentage point rate rise in July.

The central bank for the 19 countries that use the euro raised its deposit rate by a further 50bps in December – the highest rate since 2009. ECB rates had been negative – below 0% – for eight years until it hiked in July.

Meanwhile, the Fed rate hike has seen US interest rates hit a 14-year high as the battle against inflation deepens. The Fed announced it was raising its key rate by another 0.5 percentage points in early December, lifting the target range to between  4.25% and 4.5%.

Will the BoE raise rates again and by how much?

The circumstances facing each major Western economy are broadly similar, as they continue to deal with tight supply chains and worsening sentiment amid battles over Russian energy. Meanwhile, Andrew Bailey has signalled the UK’s approach wouldn’t be much different from that of the US or the eurozone. 

The Financial Times quoted Andrew Bailey, BoE governor, saying there was still more to do to justify “a further forceful monetary policy response”.

“I know raising interest rates has a real impact on people’s lives, but by raising interest rates we can bring inflation down sooner and help the economy begin to grow and prosper once more.”

Governor Andrew Bailey noted that the fall in CPI from 11.1% in October represented “the first glimmer” that inflation had begun to ease. He mentioned a potential rapid fall in inflation, “probably from the late spring onwards”.

The analysis provided by the November Monetary Policy Report noted: “The committee voted unanimously to reduce the stock of purchased UK government bonds, financed by the issuance of central bank reserves, by £80bn over the next 12 months, to a total of £758bn, in line with the strategy set out in the minutes of the August MPC meeting.”

The MPC also noted that the risks around its projections from both external and domestic factors were exceptionally large, given the very large increase in wholesale gas prices since May and the consequent impacts on real incomes for UK households and on CPI inflation. 

Given the UK government’s Energy Price Guarantee (EPG), the MPC noted that “uncertainty around the outlook for UK retail energy prices has fallen”.

Nevertheless, energy bills will still go up for consumers not on a fixed-term contract and, combined with the indirect effects of higher energy costs, inflation is expected to remain above 10% over the following few months, before starting to fall back.

“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. Monetary policy is also acting to ensure that longer-term inflation expectations are anchored at the 2% target.”

Note that analysts’ predictions can be wrong and should not be used as a substitute for your own research. Always conduct your own due diligence before trading or investing, and never invest or trade money you cannot afford to lose.

FAQs

Is the Bank of England going to raise interest rates again?

The Bank of England raised interest rates by 0.50% at its last Monetary Policy Committee meeting in early December 2022. Some analysts are predicting a further hike in February, and the Bank’s chief economist recently said that there was “more to do” with regard to tackling runaway inflation.

Note that analysts’ predictions can be wrong. Always do your own research when making investment decisions.

What influences the interest rate?

Interest rate decisions are influenced by inflation, the labour market and the government’s economic policy, as well as external shocks such as a global recession.

Will interest rates go up in 2023?

Some analysts expected interest rates in the UK to go up further still into next year as the Bank of England aims to tame the inflation rate to its 2% target. The Bank’s chief economist Huw Pill recently said that there was “more to do” with regard to tackling runaway inflation – but this is not a guarantee of a policy decision.

Note that analysts’ predictions can be wrong. Always do your own research when making investment decisions, and never invest more than you can afford to lose.

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