UK interest rates rise to 3.5%

interactive investor experts comment on today's move by the Bank of England, with more rates rises predicted in 2023.

The Bank of England voted 6-3 to raise the bank rate to 3.5%. The vote was by no means unanimous. There is a widening range of opinions from the Monetary Policy Committee with two dovish members Tenreyro and Dhingra voting to keep rates at 3%, while one hawkish member, Mann, voted for a 75-basis point increase.

With fractionally moderating inflation, the looming threat of recession and a slight tick up this week in the unemployment rate, the Bank of England rightfully voted for a more cautious approach to tightening. Fears of a tough recession are starting to rival sky-high inflation as the most pressing current economic problem with the central bank not wanting to inadvertently induce further unnecessary pain on the economy.

The Bank of England can feel justified by its counterparts stateside that it made the right decision. Both the Bank and the Federal Reserve adopted the same approach, voting for a more dovish 50 basis point hike, having both raised rates by 75 basis points at their previous meetings.

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The Bank of England’s terminal rate is expected to land somewhere around 4.25% next year.

The pound

Cable (GBP/USD) was in the red ahead of the rate decision and remains under pressure post-announcement, going against the recent uptrend, which has seen the GBP/USD rally by around 15% off the late-September lows. Although the dollar strengthened after the Fed’s rate decision last night, King dollar appears to be losing its crown with the US dollar index down more than 8% from its peak two months ago.

The European stock market

European bourses are taking their cues from a weaker Wall Street into the close last night after the Fed signalled there are further rate hikes to come next year with the ‘dot plot’ survey of policymakers’ expectations pointing to a higher-than-expected terminal rate in 2023. The FTSE 100 is under pressure but is nursing lighter losses than the DAX in Germany and the CAC in France.

Property developers such as Berkeley Group, Land Securities, Barratt Developments and Taylor Wimpey are outperforming, boosted by the BoE’s less hawkish approach.

UK banks such as Barclays, HSBC and NatWest conversely are in the red, trading lower amid concerns about pressure on net interest margins. Banks tend to fare better in a more aggressive rate rising environment as the spread between the cost of borrowing money and the amount they earn by lending it in the form of mortgages and corporate loans boosts profit margins.

Implications for savers

Commenting on the implications from a personal finance perspective,Alice Guy, personal finance editor at interactive investor, says: “The base rate has skyrocketed since December 2021, climbing from a historic low of 0.1% to 3.5%, with more rates rises predicted in 2023.

“Rates rises mean someone with a £200,000 tracker mortgage could be paying an extra £326 per month, which is an eye-watering annual increase of £3,912.

“It’s true that mortgage rates have been higher in the past, but the problem is that house prices are now at their most unaffordable level since Victorian times. Someone earning the average salary would now need to pay 8.5 times their salary to buy the average house, compared with around five times in the 1970s.

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“Whereas high house prices were more affordable in the era of ultra-low interest rates, they are now looking increasingly scary.

“There’s a toxic combination of high house prices and rising interest rates coming down the track. It’s a bleak picture for many homeowners who need to re-mortgage during 2023 and may find their repayments increasingly unaffordable.”

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Myron Jobson, senior personal finance analyst at interactive investor, adds: “The latest headline inflation figure published yesterday served as a spoiler to the level the Bank of England MPC would up the base rate. A 0.5% rate rise is not insignificant. It is the second-biggest base rate hike since February 1995. For those on a tracker mortgage deal, it could mean paying hundreds of pounds more a month.

“Cheap mortgages have gone the way of the dodo following a spat of rate rises, and borrowers coming off a fixed mortgage are set to be in for a nasty shock as the cost of a new fixed-rate deal is likely to be much higher than they were perhaps anticipating. This could not come at a worse time amid a cost-of-living squeeze on household budgets.

“The dilemma facing many homeowners approaching or at the end of a fixed-rate deal is whether to lock themselves into a higher rate mortgage over the short or long term now, or wait and see if mortgage rates will. Doing the latter and falling on to the standard variable rate could also be an expensive option as the average rate has risen to its highest level in more than a decade.

“When it comes to mortgage rates, it is important to focus on your own circumstances, for example, how long you plan on living in your current property, to determine the best course of action. Alongside rising energy bills, this additional pressure leaves people with less spare cash in the pot for pensions and ISAs.”

“Higher interest rates do not always translate to higher savings rates. It could take months for the increase in interest rates to trickle through to savers – if at all. The acceleration in the frequency of rate rises has meant that some savings providers may still be catching up to past base rate rises. Put simply, you may get a better savings rate in the near future – but there are no guarantees. The amount you are looking to save could guide your decision. An uptick in savings rates could mean the difference between pennies and hundreds of pounds depending on how much you have to save.”