The Bank of England has raised interest rates from 0.5 per cent to 0.75 per cent today, despite continued concerns over the economy and Brexit.
The move, which the monetary policy committee voted for unanimously, has put interest rates at their highest level since March 2009, when they were cut from 1 per cent to 0.5 per cent as the financial crisis raged.
Rates have never managed to climb above the level of that emergency cut and, in fact, went lower when they were slashed to 0.25 per cent after the Brexit vote – before rising back to 0.5 per cent last November.
But Tom Stevenson at Fidelity International, said that in pressing forward with the rate hike, ‘the Old Lady may have taken an unnecessary risk’.
The Bank of England’s MPC, led by Mark Carney, pictured, voted unanimously to raise interest rates.
‘Recent inflation data has been softer than expected and UK wage growth continues to remain subdued, suggesting that the UK economy may not be in as rude health as the BoE would like us to believe,’ he added.
‘On top of this, the UK economy continues to face significant headwinds from ongoing Brexit uncertainty.
‘With this in mind… the Bank also re-iterated that any future rate hikes are likely to remain at a “gradual pace and to a limited extent”. Because of this, I would expect this to be the only rate hike that the BoE makes this this year and possibly well into next year.’
The Bank had backed away from a rate rise earlier this year after growth slowed down sharply to 0.2 per cent in the first quarter, but said the economy had recovered as predicted.
It forecasts that growth rebounded to 0.4 per cent in the second quarter, with data pointing to a similar rate of growth between July and September.
In the minutes of the MPC’s meeting, the Bank said: ‘Recent data appeared to confirm that the dip in UK output in the first quarter had been temporary, with momentum recovering in the second quarter.’
The pound made gains versus the euro following the rate increase up by nearly 0.3% at 1.128, but was still trading lower by around 0.1% against the US dollar at 1.311.
Why have rates gone up today?
Economists and investors had expected the Bank to raise rates, because there were no signals that it would hold fire, unlike before the May MPC meeting and inflation report when Governor Mark Carney reined in expectations in the weeks before.
The monetary policy committee’s chief remit is to target inflation of 2 per cent, with interest rate rises used as a brake on the economy. By raising the cost of borrowing, an interest rate rise reduces demand and leads to banks creating less money when they issue loans.
A lower level of money creation is seen as reducing inflationary pressures from wage rises and spending. With unemployment at record lows and slack in the economy dissipating, economists suggest inflation may overshoot without a rate rise.
There is also an argument that the Bank should raise rates while the going is good, to give itself wriggle room when a recession hits in future.
In June, the possibility of a hike in interest rates edged closer as chief economist Andy Haldane joined two other members of the MPC in voting in favour of a rise.
UK interest rates have been lingering at record lows since the financial crash of 2008
How is the economy doing?
Over the last few months, statistics providing an insight into the state of the economy have been mixed. GDP growth has picked up recently but on Wednesday, it was revealed that growth in the manufacturing was its weakest for a year and a half last month.
There are also still major concerns over the UK consumer and the retail sector, in addition to the prospect of a no-deal Brexit. But the property market remains strong across the UK, with Nationwide’s house price index showing that the cost of a home increased by 2.5 per cent in the year to July, up from 2 per cent in the year to June.
Despite the mixed economic backdrop, most economists had pencilled in a rise today.
WHAT DOES THE BANK OF ENGLAND THINK?
In the quarterly inflation report that accompanied the rates decision today, the Bank kept its forecast for growth this year unchanged at 1.4%, but increased the outlook for 2019 to 1.8% from the 1.7% previously predicted.
It continued to pencil in growth of 1.7% for 2020.
The report showed its predictions are based on financial market expectations for rates to rise to 1.1% by mid-2021, which would suggest two more quarter-point rises.
But it also said inflation – currently running at 2.4% – was set to rise slightly higher than it had predicted in May’s set of forecasts after recent falls in the value of the pound and higher energy prices.
The Bank confirmed in the minutes that an ‘ongoing tightening of monetary policy’ would be needed to rein in inflation over the ‘more conventional’ two-year horizon, if the economy grows in line with its forecasts.
Its rate hike comes as the squeeze on household finances has eased, with wage growth just outstripping inflation, which is helping growth to pick up.
The Bank said retail sales had surged by 2.1% in the second quarter, boosted by the recent sunny weather.
‘Weather effects – both the snow-related disruption in February and March and the unseasonably warm weather and long sunshine hours in May and June – seemed to have accounted for around half of the second quarter rise,’ it added.
How will it affect borrowers and savers?
Raising interest rates by 0.25 percentage points adds about £20 per month to the cost of a £150,000 tracker mortgage.
Those on standard variable rate deals will have to wait to see if their bank or building society pass on the hike, while homeowners with fixed rate mortgages are protected from higher costs.
David Hollingworth at L&C Mortgages said that although many borrowers appear to have looked ahead and fixed their mortgage rate, ‘those that have failed to do anything so far may finally be triggered to revisit their situation’.
‘Although rates have been drifting upwards since the run up to the last rate hike, the fixed rate options are still very competitive,’ he added. ‘Those most vulnerable to rising rates will be borrowers on their lender’s standard variable rate.
‘An increase of 0.25 per cent for a £200,000 25 year repayment mortgage could increase monthly payments by around £25 or more. Reviewing their rate could offer them substantial cost savings as well as being able to lock their rate down and protect any further rate rises.
‘Assuming that lenders apply any increase to their SVR, average SVR rates could be around 5 per cent, although the range of SVR varies widely between lenders.’
Savers who have suffered a miserable decade will be cheered by the first move above 0.5 per cent since 2009, although the rates on top accounts have already moved up in recent months.
Savers have suffered dismal returns on their deposits for years and a rate rise would give them a little solace, although savings rates have shifted up slightly in recent months.
Will this have an immediate effect?
The decision to raise rates will come as a blow to some borrowers on variable rate mortgages, but offer relief to savers who have seen paltry returns on deposits since the financial crisis rate cuts.
Savers have been warned not to expect a dramatic increase in their returns.
‘Do not expect things to happen automatically. Savers have to be active to find better returns’, Tom Adams, of comparison site Savings Champion said.
Mortgage borrowers with tracker rates linked to the Bank of England base rate will see their monthly repayments automatically rise, but banks and building societies can choose by how much they raise their own standard variable rates.
Borrowers will have to wait and see on this.
Rising rates are typically seen as posing a threat to the housing market. However, many believe that with mortgage rates near record lows any slow and steady shift up will be absorbed.
The struggling UK retail sector will not welcome the rate rise.
What about Brexit?
On Wednesday, the National Institute of Economic and Social Research warned that the Bank of England could be forced into an embarrassing reversal on a rate hike because of the potential deleterious effects a ‘no-deal’ Brexit would have on the UK economy.
A hard Brexit would take £800 out of the pockets of each UK citizen and put a brake on the UK’s already weak economic growth, the forecasting group’s research suggested.
That could force the Bank of England’s policymakers to reverse any rate rises that they execute in the coming months.
And the stock market?
The London stock market fell today though it is hard to pin this on the rate rise as one was probably priced in by most traders.
The FTSE 100 index slumped 1.27 per cent or 97.5 points to 7,555.4 by 1230, having also fallen sharply yesterday amid fears over Trump’s plans for trade from China.
Rising interest rates can be a good sign for investors in the sense that the backdrop to hikes is usually an economy doing well.
However, due to the dominance of big companies that do business overseas in the FTSE 100 a rise in rates can dent share prices. This is because rising rates lift sterling, which means that overseas earnings translate into less in pounds when companies report.