Bank of England wields sledgehammer to fight inflation

The UK central bank has raised interest rates for the 13th consecutive time to 5%.

The Bank of England today increased the base rate for the 13th consecutive time from 4.5% to 5% in a bid to curb inflation.

A hike of 50 basis points was larger than the 25 basis-point increase most commentators were expecting. Last time rates were this high was in 2008, during the global financial crisis.

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Commenting, Myron Jobson, Senior Personal Finance Analyst, interactive investor, says: “Inflation is not playing ball, therefore, the Bank of England felt it had little option but to crank up interest rates even more this time around, despite the broader implications of the uptick in borrowing costs.

“To get a sense of whether embedded inflation is becoming a problem, you have to strip out the highly volatile prices such as food and energy from the picture. That’s why the Bank of England focuses on ‘core’ inflation to gauge if inflation is getting built into the economy. The fact that core inflation rose to its highest level in 31 years, hitting 7.1% in May despite consecutive interest rate hikes is concerning.

“Interest rate rises have been called a blunt instrument, but with very few tools in the box, it seems a sledgehammer is required to fight inflation. There has been talk of a need for the UK’s central bank to deliberately cause a recession. But this strategy comes at a high cost. In the 1980s, it took double-digit unemployment to get rid of the embedded inflation from the 1970s.

“In the meantime, many households will continue to wrestle with a double whammy of rising borrowing costs and stubbornly high inflation, which threatens to lay waste to finely tuned budgets.

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“Those seeking to remortgage, and aspiring homebuyers have found themselves in the clutches of a mortgage affordability squeeze not felt since the aftermath of the ill-fated mini-budget in September last year and the subprime crisis, which erupted in 2007. For first-time buyers, rising rents don’t help matters, scuppering attempts to build a big enough deposit to buy a house.

“The reprieve in savings rates is a positive amid the gloom. Easy-access savings rates have hit 4% for the first time since 2009, and market-leading one, two, three and five-year fixed bonds all offer 5.30% or more.

“How high savings rates will go is anyone’s guess, but it's worth keeping in mind that the extent of the interest rate increase and the competitiveness of savings rates may vary. Different savings providers offer different rates, so shopping around for the best deal remains the name of the game.

“It is important to bear in mind that the buying power of cash saving is being hacked away by stubbornly high inflation, which at 8.7% far outstrips the market-leading savings rates. Those who can afford to put money away for five years or more should consider investing for the potential of long-term inflation-beating returns.

“It remains important to keep tabs on your spending habits to get a better idea of the goods and services that are eating most into your budget, and where you could cut back as inflation remains stubbornly high and the cost of borrowing rises.”

Alice Guy, Head of Pensions & Savings, interactive investor, says: “Interest rate rises are good news for savers who can now find long-term interest rates over 5%, but for pension and ISA investors the picture is more complex.

“For retirees who are already drawing a pension, it’s a tough situation as high inflation means they may need to draw more from their pension to cover daily living costs. There’s a risk that some pensioners will deplete their pension pot and end up running out of money earlier than expected. If pensioners do have cash savings, then it’s important to shop around to get the best rates as they vary significantly between providers and products. If you can afford to lock up cash in a fixed-rate bond, then you can often secure a better rate.

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“For pension savers who are still a long way off retirement, it’s important to keep focused on the long-term goal of investing to fund a comfortable retirement. The good news is that long-term investing is the best way to beat inflation over time and pension saving is also topped up by tax relief and employer contributions, making it one of the best deals around. If you do need to take a pause on contributions, then remember to come back and start contributing again in the future if your circumstances improve.

“For ISA investors, the best cash savings rates for years look extremely tempting, but it’s important to match your investments to your needs. It’s a good idea to have a rainy day cash fund of three to six months’ worth of expenses in case you fall on hard times. In contrast, it often makes sense for long-term investors to focus on stocks and shares as investing tends to outperform cash in the long run. Many investment trusts are currently trading on attractive discounts and historically offer attractive returns over time.”