The Bank of England has increased its base rate from a record low of 0.1% at the end of 2021 to 2.25% on Thursday, it’s seventh rise in a row!
This follows the American Federal Reserve’s decision to raise interest rates to 3% – 3.25%, as Central Bankers attempt to tackle the cost-of-living crisis.
But this begs the question why?
The rate of inflation is at its highest level in 40 years and is being driven by an economic mismatch. Consumer demand has remained high since the pandemic, but the supply of goods has not been able to keep up, as disruption to businesses and transportation has slowed production, forcing companies to increase prices.
This has been compounded by the war in Ukraine which has increased the cost of crude oil, gas, and food.
Furthermore, whilst average wages rose 4.7% between April and June, this has been outpaced by inflation which has meant that the ‘real value’ of pay has reduced by 3%. (Source: Office for National Statistics).
The response to rising inflation has traditionally been to increase interest rates. In theory this should reduce the demand for borrowing as it becomes more expensive, which in turn means people have less money to spend and prices are forced to drop.
Of course, this also means those already on variable rate mortgages, or with credit card debt will see their rates increase. In turn though, banks should pass on interest rate raises to savers.
However, given that the current level of inflation is primarily being driven by Global issues with energy and food supplies there is an argument that the Bank’s interest rate rises will have a limited effect and could even push the UK economy into recession.
There may be some relief this winter though as the new Prime Minister plans to slash taxes and energy bills, whilst there will also be focus on making the UK more energy independent.
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If you or someone you know is concerned about how interest rate rises and inflation may affect your finances, it could be wise to seek professional guidance on the matter.
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