The Bank of England (BoE) raised again its key interest rate by 50 basis points (bps) in the September meeting in an effort to cool soaring inflation. It was the seventh hike this year, bringing the interest rate to 2.25%, up from 0.50% in January and 0.25% in December 2021.
Meanwhile, UK inflation in the 12 months to August rose by 9.9%, down from a fresh 40-year high of 10.1%in July. With more rate hikes expected this year, what will be the projected interest rates in five years in the UK?
Here we take a look at the UK interest rate history and other factors that influence the central interest rate decisions over the years as well as the latest analysts’ forecast for the UK interest rate.
What is the Bank of England (BoE)?
The Bank of England (BoE) is the central bank of the United Kingdom. Founded in 1694, it is the second oldest central bank in the world after Sweden’s Sveriges Riksbank.
BoE was founded as a private bank to the government. It was established by Royal Charter in 1694 granted by King William and Queen Mary.
The bank’s main purpose at the time was to raise £1.2m in loans for the government to finance the war against France. More than 1,200 people bought the ‘bank stock’, or shares, issued by BoE, making them the first shareholders.
They came from a variety of backgrounds, trades and professions, including carpenters and grocers, merchants, doctors, knights and royalty. King William and Queen Mary, too, were among the original stockholders.
As a central bank, BoE’s primary mandate is to keep prices stable by making sure that inflation stays at 2%. To do so, the BoE changes its key interest rate, known as the bank rate, to control inflation.
The task to adjust the bank rate is in the hands of the Monetary Policy Committee (MPC), which consists of nine members – the governor; the three deputy governors for monetary policy; financial stability and markets; and banking. There is also a chief economist, and four external members, who are appointed directly by the chancellor of the exchequer – the second most important member of the cabinet after the prime minister.
Members of the MPC are appointed for a set period and may be replaced or reappointed. The committee makes decisions on what monetary policy action to take eight times a year, or once every six weeks.
Other BoE functions include producing bank notes, supervising payment services, and regulating and supervising major banks and other financial institutions, such as credit unions and insurers.
The BoE also manages the UK’s gold reserves and gold held by other banks. BoE vaults contain approximately 400,000 gold bars.
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UK interest-rate history
The BoE started to aggressively cut its key interest rate in February 2008. The effect of the global financial crisis, which started in the US with the housing market bubble in 2007, had begun to hit the UK economy.
Over 2008, BoE made five rate cuts, which dropped the rate from 5.25% in February to 2% in December, a level last seen during banking crises in the 1880s and 1890s, according to the International Monetary Fund (IMF). It was also the lowest level in Bank of England’s interest rate history after the Great Depression and World War II.
The BoE continued its rate-cutting policy well into 2009. In the first quarter of 2009, the BoE made three consecutive rate cuts from January to March. The cuts lowered the UK interest rate to 0.5% in March 2009 from 1.5% in January, as consumer spending continued to weaken, business investment fell and unemployment rose.
Past performance is not a reliable indicator of future results
The bank maintained a 0.50% rate until August 2016 when the rate was cut to 0.25%. The first rate cut in seven years was taken to sustain growth and employment after the UK voted to leave the European Union (EU) in the Brexit referendum in June 2016. The vote caused the British pound (GBP/USD) to fall, though by 2018 it had recovered to the $1.40-mark.
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In 2017 and 2018, the BoE raised interest rates by 25 basis point (bps) to 0.5% and 0.75% as inflation rose above the 2% target due to depreciating sterling and higher energy prices. The bank maintained the rate at 0.75% for two years until March 2020, when Covid-19 pandemic lockdowns shut down the global economy.
In March 2020, BoE had two interest cuts – on 11 and 19 March – which brought the UK interest rate to an all-time low of 0.1%. The BoE’s steep rate cut followed the footsteps of other central banks and governments that rolled out emergency measures to help their economies weather the pandemic.
First bank-rate increase post-pandemic
The near zero rate was kept until December 2021 as the UK and other countries gradually reopened their economies.
As inflation rose in line with recovery, the BoE increased its bank rate to 0.25% on 16 December 2021 from the low of 0.1%. The UK became the world’s first leading economy to increase its interest rate after the pandemic.
The bank cited inflation, which accelerated to 5.1% in November 2021 from 3.1% in September 2021, as one of the factors behind the rate increase.
The rate rise happened as the UK battled a fresh surge in Covid-19 cases brought by the spread of the Omicron variant. The BoE lowered its fourth-quarter gross domestic product (GDP) expectations from 1% to 0.6%.
At that time, the bank expected inflation would peak at 6% in April 2022. However, surging energy and food prices caused largely by Russia’s invasion of Ukraine, have continued to push inflation above the December forecast and led to five rates increase by July 2022.
Susannah Streeter, senior investment and markets analyst at Hargreaves Lansdown, said that compared with August 2007 when UK interest rates were at 5.75%, the current low interest-rate environment left little room for the central bank to manoeuvre.
Inflation set to peak in October
Inflation is likely to be the primary factor that dictates the UK’s key interest rate in the short to medium term.
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At its September meeting, the BoE lowered its inflation forecast for October to just under 11%, down from 13.3% projected in the bank’s August monetary report. In its August’s monetary policy report, the BoE warned that price gains would remain raised throughout 2023. In two years’ time, the Bank expects inflation to return to the 2% target as external influences continue to wane and domestic factors fade.
Bill Diviney, ABN-Amro Group’s senior economist, said on 31 August that he expected the inflation shock in UK to intensify after the Office of Gas and Electricity Markets (Ofgem) announced an 80% rise in the energy price cap – pushing inflation more firmly into double-digit territory when the cap is officially raised in October.
The energy price cap restricts the unit rate and standing charge that energy suppliers can charge for their ‘default’ tariffs. Ofgem sets the rates, which will now be reviewed quarterly from twice a year previously, Ofgem announced on 4 August.
On 26 August, Ofgem increased the energy price cap, which would see average household bills rise to £3,549 per year from the level of £1,971 set in February, due to record high global gas prices caused by Russia’s invasion of Ukraine. The UK government has now pledged to cap that figure so that the average bill would be no more than £2,500 – though heavy users would still pay more.
On 26 August, ABN-Amro revised its forecast for UK inflation to average 9.2% in 2022, up from 8.8% previously, and 8.4% in 2023, up from previous estimate of 6.1%.
ING Group in its updated forecast on 5 September expected UK inflation to reach 10.2% in the third quarter, peaking at 15.2% in the first quarter of 2023 before gradually easing to 3.5% in the final quarter of 2023. Overall, ING forecast UK inflation to average 9.7% in 2022, rising to 10.1% in 2023 and plummeting to 0.5% in 2024.
UK to enter recession
Gross domestic product (GDP), a key indicator of the health of the economy, is another figure closely watched by the BoE when deciding its monetary policy stance.
The bank forecast the UK would enter recession in the fourth quarter of this year due to temporary internal and external headwinds.
The BoE projected the GDP growth rate at 2.3% from the previous forecast of 2.9% in the third quarter of this year. The reading was expected to contract to -2.1% in the third quarter of 2023. In 2024, the BoE suggested the figure could stabilise and grow slightly to 0.4% in 2025.
The UK’s GDP grew by 0.2% in July after a fall of 0.6% in June, the Office of National Statistics (ONS) announced on 12 September.
ING forecast the UK’s economic growth would slow to 0.5% in the fourth quarter of 2022 and enter negative growth of -0.6% in the first quarter of 2023.
The Dutch bank forecast the UK’s GDP to remain contracted at -0.6% until the third quarter of 2023, before recovering to growth of 0.1% in the fourth quarter of 2023. Overall, the ING expects the UK economy to grow 3.5% on average in 2022, contracting to -0.4% in 2023 and recovering to 1.2% in 2024.
Scotia Bank predicted the UK’s GDP growth rate to average 3.2% in 2022 and 0.6% in 2023.
ABN-Amro revised downward the UK’s GDP growth rate for 2022 to 3.1% in its August forecast, from 3.6% in the June forecast. It also lowered the projection for the UK’s GDP growth for 2023 to -0.8% from 0.3% in its previous forecast in June.
Labour market to remain tight
The UK unemployment rate stood at 3.8% in the three months to May, 0.1% lower from the previous three months. The BoE expected the labour market to remain tight and only start to rise from its current level from mid-2023.
“Given continued elevated recruitment difficulties due to the fall in the labour force since the start of the pandemic and strong labour demand, firms are forecast to respond initially to the weakness in demand by using their existing inputs less intensively. So although economic slack emerges in 2022 Q4, the labour market is expected to remain tight over the next year,” the Bank said.
The Bank forecast the unemployment rate to accelerate at 4.4% in the third quarter 2023 from 3.7% in the third quarter 2023. The figure was then expected to surge to 5.5% in the fourth quarter of 2024 and to 6.3% in 2025.
ABN-Amro forecast UK employment to rise to 4.5% by the end of 2023 from 3.9% in 2022.
Projected interest rates in 5 years in the UK
TradingCandles.com’s Razaqzada expected the Bank to increase UK interest rates to around 2.5% in the next months before pausing the hikes to meet the 2% inflation target in the medium term.
Economists at Schroders, global asset and wealth manager, expected UK interest rates to rise to 2.25% in the first quarter of 2023.
ABN-Amro forecast 50bp hikes in November and the final 25bps hike in December meetings, which could bring the policy rate to a peak of 3% by December, the bank said in its latest prediction on 31 August.
“Our view assumes the BoE’s own longer term projections are realised, as these suggest such a sustained high level of interest rates would lead to an even deeper recession than we currently forecast, with inflation significantly undershooting the Bank’s 2% inflation target by 2024. With this in mind, we continue to think the Bank will start cutting rates back again late next year, assuming inflation and labour market tightness have sufficiently cooled at that point,” said Diviney.
Scotia Bank estimated the BoE would keep its bank rate at an average 2.25% in 2022 and 2023, as of 29 July.
In terms of the UK interest rate forecast for the next five years, ING expects BoE to maintain its key rate unchanged at 2.75% from the fourth quarter 2022 until the third quarter of 2023. ING predicted the BoE would cut the interest rate to 2.5% in the final quarter of 2023 and to 2% in the first quarter of 2024. The bank forecast the BoE would keep the rate at 2% until the fourth quarter of 2024.
The BoE itself forecast it could raise the key interest rate to 3% in the third quarter of 2023, from 1.6% in 2022. The bank expected to ease its monetary policy by cutting the rate to 2.5% in the third quarter of 2024 and 2.2% in the third quarter 2025.
Neither the Bank nor analysts provided a UK long-term interest rate forecast beyond 2025, as there are many complex factors at play that can affect indicators for interest rate decisions, such as inflation, economic growth rate and unemployment.
The bottom line
Analysts forecast that the BoE will continue to hike rates at least until December this year to cool expected rising inflation before taking a pause as high interest rates start to affect the economic growth rate.
The BoE estimated the interest rate to peak at 3% in the third quarter 2023 before cutting it to 2.5% and 2.2% in the third quarter of 2024 and 2025, respectively.
Remember that analysts’ predictions can be wrong. You should always conduct your own due diligence before trading. And never invest or trade money you cannot afford to lose.
When will interest rates rise in the UK?
Analysts expect the BoE to continue increasing the rate until December. The Bank of England is forecast to hike its key rate until the third quarter of 2023. Note that all predictions can be wrong. The next BoE meeting is on 3 November.
How high will UK interest rates go?
The Bank of England forecast that its key rate could peak at 3% by the third quarter 2023. TradingCandles.com analyst Fawad Razaqzada forecast that UK interest rates could go as high as 2.5% by the end of 2022, while ABN-Amro forecast the rate to peak at 3% by end of 2022. Note that analysts’ predictions can be wrong.
What will UK interest rates be in 5 years?
The BoE and analysts did not provide projected interest rates in 5 years in the UK due to complexity and uncertainty of giving long-term predictions. The BoE forecast that it could raise the key interest rate to 3% in the third quarter of 2023, from 1.6% in 2022. The bank expects to ease its monetary policy by cutting the rate to 2.5% in the third quarter of 2024 and 2.2% in the third quarter 2025.