The Bank of England raised interest rates to 5 per cent on Thursday (June 22) after inflation remained higher than expected in May.
Reports of the stubbornly high inflation rate led many to expect the Bank to raise the rates, though the 0.5 per cent hike was on the upper end of most experts predictions.
The news comes as many have begun to expect that the base rate could rise to 6 per cent by the end of 2023.
The inflation rate of 8.7 per cent announced on Wednesday meant it had not changed and that it was higher than expected for the fourth month in a row.
Interest rates dictate the cost of borrowing, and are now at their highest level since October 2008, during the global financial crisis.
The Bank of England has an official target of 2 per cent – a rate not achieved since July 2021 – and Rishi Sunak has pledged to halve the rate of inflation by the end of the year.
Mr Sunak and Labour leader Sir Keir Starmer spent Prime Minister’s Questions debating who was to blame for the financial situation.
But why are rates still rising, how high could they go and will they start to come down soon?
We explain the key details and the why interest rates remain so high.
Why are interest rates going up?
Interest rates in the UK are currently 5 per cent – the highest rate in 14 years – up from 0.1 per cent in December 2021. Since then the Bank of England has increased rates 13 times in a row.
Interest rates are rising to try to ease inflation, which is at 8.7 per cent – well above the Bank of England target of two per cent. The idea is that, by raising interest rates, households will spend less and this should mean inflation will drop.
Prices have been rising steadily since the easing of Covid restrictions for several reasons. Pent-up demand meant people spent more money but, because companies are struggling to meet demand, prices are rising. Gas prices also increased hugely since Russia’s invasion of Ukraine.
How does this affect inflation?
When the Bank of England raises interest rates, this often increase the amount that people can make from their savings, while increasing the cost of borrowing.
In turn, this encourages people and businesses to spend less, and save more, which reduces the amount of money in circulation.
By reducing the amount of money in circulation, the value of that money consequently rises, and currency has more purchasing power.
This purchasing power, over time, is expected to reduce the high inflation seen across goods and services.
How high could interest rates rise?
The Bank’s monetary policy committee meets eight times a year to decide interest rate policy.
Yet another upward move to 5 per cent was seen as more likely than not at the August meeting with a one in four chance of 5.25 per cent being hit by the autumn. Further rises on this scale would have major knock-on implications for economic growth, increasing the risk of a recession and hurting house prices as mortgage rates rise again.
When will interest rates come down?
Last week, the International Monetary Fund said interest rates in major countries are expected to fall to pre-pandemic levels. Before the Covid crisis, the UK base rate was 0.75 per cent. However, its report came before the ONS’s worse-than-predicted inflation figures.
