The Bank of England has just announced the largest increase in interest rates seen in the UK for 33 years – and it has increased its recession prediction.
It comes amid a pretty bleak backdrop, too. The cost of living crisis is expected to worsen as food prices still climb, while fears of energy blackouts this winter are rising.
Unemployment levels are expected to double as well.
And inflation is already at a 40-year-high, which is why the Bank has just lifted interest rates from 2.25% to 3%.
Here’s what this new announcement means and how it will affect you.
Will there be a recession?
The Bank predicted back in August that there would be a long, but shallow recession in the UK.
Governor Andrew Bailey warned that a recession would last for more than a year, and inflation would reach 13.3%. However, he said it was not expected to hit the economy as hard as the 2008 financial crash.
In its latest announcement, the Bank has increased its prediction for a “prolonged recession” from just over a year to two years.
What’s happening to interest rates?
An interest rate is the amount it costs to borrow money.
The Bank has just increased them from 2.25% to 3% – this is the highest rate since autumn 2008. By pulling up the rates, the cost of borrowing goes up, impacting everything from credit cards and savings to mortgages.
As this is a 75 basis-point rise, that’s the most sudden increase in rates since 1989 (excluding one particularly alarming Black Wednesday back in 1992).
This rate is decided by the Monetary Policy Committee (MPC), a team of nine people who all work for the Bank.
For the most part of the last three decades, interest rates have not increased by more than 0.5 percentage points, showing just how significant Thursday’s announcement is.
It’s also the eighth consecutive increase in interest rates from the Bank.
Bailey defended the rise, saying: “If we do not act forcefully now, it would be worse later on.”
He added: “This is a difficult time. There is no easy outcome.”
Why are interest rates so important?
Interest rates are how the Bank controls fluctuations in the economy.
They used to be much higher in the UK, but the 2008 financial crash meant they were dramatically cut to reduce the fallout.
They’ve been at historically low levels since.
Only in 2021, they fell to 0.1% – a stark contrast to current rates, which are back to those seen before 2008.
What does this mean for inflation?
Inflation is the rate at which prices rise, and so interest rates are used by the Bank to balance it out and reduce soaring prices.
This is because if it costs more to borrow money, people are less likely to lend it. This should steady out sudden economic changes.
But the Bank has to make sure not to stop economic growth altogether by preventing people from spending completely.
If the economy stops growing, the UK goes into a recession.
The Bank has been tightening its monetary policy since inflation has soared to a 40-year high of 10.1% in September.
For reference, the Bank’s target for inflation is only ever 2%.
This increase comes from the food prices soaring, and the ongoing energy crisis.
Why do markets need reassurance?
After the disaster of Liz Truss’s mini-budget – made up of £45 billion unfunded tax cuts – markets were spooked, meaning investors pulled their money out of the UK.
This made the value of the UK pound plummet, triggering one of the more disruptive periods for the UK economy.
The Bank then intervened in an emergency by buying up to £65 billion government bonds.
The markets settled when Jeremy Hunt took over as chancellor, and became more stable once Rishi Sunak became prime minister, vowing a new economy strategy while tearing up the mini-budget.
What about Jeremy Hunt’s fiscal statement?
The Bank is having to make these decision with little direction from the Treasury, considering Hunt has pushed the fiscal statement with tax rises and spending cuts back until November 17.
Originally, it was meant to be published three days ago on October 31.
And there is speculation about just what Hunt and Sunak will do to plug “fiscal black hole” in the UK economy.
Senior economist at fund manager Cardano, Shewta Singh, told The Guardian that this means the Bank risks “doing too much” with this announcement, without knowing what the government plan on doing.
But, if Sunak and Hunt’s plan is dependent on taking action after the next general election, then the Bank may look to take more preventative measures against inflation at sooner rather than later.
What about the rest of the West?
The UK is not alone with these economic struggles. Both the US and Europe are facing similar problems in the aftermath of the Covid lockdowns and due to Russia’s invasion of Ukraine. Moscow has been using its energy output as leverage against Ukraine’s allies, to deter any support for Kyiv.
The US Central Bank has also raised its main lending rate by another three-quarters of a percent on Wednesday – the same rate as the Bank.
The European Central Bank’s interest rate increase is also the same.
What about my expenses?
The Bank of England sets the central bank rate for interest rates, but lenders do not have to stick to it.
Data from MoneyFacts shows that the average two and five-year fixed mortgage rate being offered is still at more than 6% – almost three times what was on offer last year.
Around three quarters of mortgages are fixed, meaning the payment is consistently the same and so will not be impacted – for now.
The remaining households with mortgages will see their monthly repayments increase.
Credit cards, bank loans and car loans will be impacted, too – and lenders could increase fees on that now interest rates have risen.
Even savings could be affected. Individual banks pass on the interest rate rises usually, so savers get more return back – but, for people putting money away now, these interest rates do not keep up with rising prices.
What else does the Bank think will happen?
The Financial Times warned that the signals the Bank sends about the future are just as important.
The next announcement will not be made until December 15.
But, the deputy governor, Ben Broadbent, previously warned that pricing in rates would not rise above 5%. He claimed that if interest rates reached this level, it would take a deeper recession to bring the inflation rate back to the central bank’s 2% target.
Now, the Bank predicts this to go up to 5.25% by the third quarter of 2023.
However, it also forecast that inflation will fall sharply from the middle of next year.