Advertisement

Why have interest rates risen and how will it affect you?

  • Video report by ITV News Business Editor Joel Hills

The Bank Rate is rising for the first time in a generation.

The cost of borrowing has been set at unprecedentedly low levels since financial crisis began in 2008.

The Bank of England signposted its intention to raise interest rates in advance and in neon lights.

This move - from 0.25% to 0.5% - can come as no surprise but the key judgements that underpin the decision are interesting.

Why did the Monetary Policy Committee vote to increase interest rates?

  • Global economic growth is strong and getting stronger. Our prospects are tied to those of the counties we trade with. They are expected to get more prosperous and the Bank of England assumes we stand to benefit, although it's worth noting that the performance of the UK economy relative to other advanced economies has got worse.
  • An increase in UK exports is set to off-set weakening consumer demand. Household incomes have been hit by the slump in the pound, post-Brexit. Happily the Bank notes that the weaker pound is beginning to foster a pick-up in trade.
  • The "slack" in the economy is almost gone. The Bank of England believes the ability of the economy to grow without prices rising sharply is diminished. Some will see a Brexit effect here (with reason) but low productivity is the underlying problem and that is a hangover from financial crisis.
  • Domestic inflation pressures are on the rise. The rise in prices and the squeeze on living standards we have seen since the referendum has been largely down to the slump in the value pound. The Bank believes this bout of "imported" inflation is peaking however with unemployment down to a 42 year low and population growth set to fall, along with net migration, it expects domestic costs to start building - most obviously in the form of higher pay.
Rates have gone up from 0.25% to 0.5%. Credit: PA

The Bank of England believes that the cruising altitude of the UK economy has fallen since 2008.

Recent economic growth - while steady - has been fuelled by more people in work, not because we are working more effectively or better.

GDP growth of 0.4% may seem weak by historical standards but, in the Bank's view, it's probably the new normal.

The Bank has set out its thinking, but there are those who believe the Monetary Policy Committee has jumped the gun.

They will point out that wage growth currently is anaemic and there are plenty of arrows which are pointing in the wrong direction: retail sales slumped last month, new car sales have fallen for six consecutive months.

Critics will argue that hiking the cost of borrowing at a time when economic growth is unheroic and Brexit talks with the EU appear stuck in a rut is both unwise and an unnecessary risk.

  • What does it mean for savers and borrowers?
It's bad news for people with mortgages. Credit: PA

The Bank of England judges the economy is ready for higher interest rates and that households and businesses will cope too.

Savers will rejoice, of course, but higher interest rates takes cash out of the pockets of those who have borrowed.

Anyone with a mortgage - there are 11 million outstanding mortgages in the UK - will want to know what the Bank's ambitions are.

The Bank argues that the cash-flow implications will actually be limited.

Most households are tied into fixed-rate mortgages and will be protected initially; households generally are less indebted than they were 10 years ago.

  • What does it mean for the future?
The Bank of England hope the hike will boost the economy and value of the pound. Credit: PA

The Bank calculates that if Base Rate rises from 0.5% to 1% over the next three years - as the market expects - then economy will continue to grow modestly.

The Bank is also promising future rises will be "gradual" and "limited" although quite what that means is unclear.

Context is important. Today's rise is a modest increase and one that brings us back to where we were last August, when the Bank of England cut interest rates in the face of high anxiety following the referendum on Brexit.

The decision is hardly a hand-brake turn, more an easing off the throttle. Monetary policy is still what economists call “accommodative”.

The bigger question is whether today marks a one-off or the beginning of a slow march back to more a more "normal" levels and indeed what that normal level is.

The market may be under-estimating the scale of the changes that lie ahead.