Interest rates: How a rise affects you and your money


Block of flats

By Kevin Peachey

Cost of living correspondent

The Bank of England has put up interest rates 14 times in a row in an attempt to slow rising prices.

In August, the Bank rate, set by the Monetary Policy Committee, went up to 5.25% from 5%.

That means further pain for some homeowners, but is better news for savers.

How high could interest rates go?

The Bank rate is currently at its highest level for 15 years.

The theory is that raising interest rates makes it more expensive to borrow money, meaning people have less to spend, reducing demand and inflation.

The Bank has put up rates 14 consecutive times since December 2021 to try to bring inflation closer to its target of 2%.

But, so far, the impact has been limited and is likely to take more time to feed through.

Prices rose by 7.9% in the year to June, according to the Office for National Statistics (ONS). This was lower than 8.7% in the year to May, and down from the peak of 11.1% in October 2022.

However, that is still almost four times the Bank’s 2% target.

Concerns also remain over the “core inflation” rate – a measure which strips out volatile factors such as food and energy. Although it dipped slightly in June, it is still relatively high.

As a result, there is uncertainty about what will happen in the coming months, although financial markets now think rates won’t rise as high as previously thought.

At one point, UK rates were expected to rise above 6%, but now markets expect the peak rate to be below 6%.

The Bank has to balance the risk of damaging the economy, which has shown little sign of growth, with the need to slow price rises.

How do interest rates affect me?

Just under a third of households have a mortgage, according to the government’s English Housing Survey.

When interest rates rise, more than 1.4 million people on tracker and standard variable rate (SVR) deals usually see an immediate increase in their monthly payments.

The rise from 5% to 5.25% means those on a typical tracker mortgage would pay about £24 more a month. Those on SVR mortgages would face a £15 jump.

Three-quarters of mortgage customers hold fixed-rate deals.

Their monthly payments may not change immediately, but higher interest rates mean housebuyers – or the 1.8 million people expected to remortgage this year – will have to pay a lot more than if they had taken out the same mortgage a year or more ago.

An average two-year fixed deal, which was 2.29% in November 2021, is now well above 6%.

The so-called “mortgage bomb” has become a huge economic and political issue.

As people roll off cheap fixed-rate deals onto products with much higher rates, their monthly repayments can soar by hundreds of pounds.

You can see how your mortgage may be affected by rising rates with our calculator:

Bank of England interest rates also influence the amount charged on credit cards, bank loans and car loans.

But even in April the average annual interest rate was 21.86% on bank overdrafts and 20.13% on credit cards.

Lenders could decide to put prices up further, if they expect higher interest rates in the future.

Image source, Getty Images

Image caption,

Low interest rates are good for borrowers, but bad for savers

Individual banks and building societies usually pass on interest rate rises to customers.

There are some good deals on the market, so analysts say that customers should shop around, as many will be on accounts paying little or nothing.

The UK’s financial watchdog recently warned that banks will face “robust action” if they offer unjustifiably low savings rates to their customers.

Although many saving accounts are paying more, even the best interest rates aren’t keeping up with inflation.

This means the value of cash savings – its buying power – is falling in real terms.

Why have prices been going up?

Inflation has gone up worldwide, after Covid restrictions eased and consumers spent more.

Many firms experienced problems getting enough goods to sell. Oil and gas costs were also higher than they had been – a problem made worse by Russia’s invasion of Ukraine.

Although many elements of inflation are global, there are also domestic factors at play in the UK, including rising wages.

Are other countries raising their interest rates?

Central banks around the world have also been raising interest rates to try to tackle high inflation.

The US central bank has announced big rate rises which have taken its key rate to levels not seen for 22 years.

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