Energy costs and interest rates rise as living costs soar

The Bank of England has announced it has increased the base interest rate from 0.25% to 0.5%, whilst Ofgem, the UK energy regulator, announced the UK’s energy price cap will increase by £693 from April.

This is the second month in a row where interest rates have risen and according to experts, two more interest-rate rises are also expected throughout 2022.

The move comes off the back of inflation rates rising to a 30-year high of 5.4% in January, and the idea of raising interest rates is to help control the price rises caused by inflation. However, raising interest rates can mean higher mortgage costs for many homeowners.

According to the market research company Kantar, grocery prices rose 3.8% over the four weeks to 23 January compared with the same period last year.

Under Ofgem’s new energy price cap, those on default tariffs paying by direct debit will see an increase of £693 from £1,277 to £1,971 per year. Prepayment customers will see an increase of £708 from £1,309 to £2,017.

This is the second major increase in energy bills in six months and the largest on record. Ofgem said the increase is due to the rising global gas prices.

The cap is expected to increase for an estimated 22 million customers, with those on a default tariff who haven’t switched to a fixed deal and those who remain with their new supplier after their previous supplier exited the market affected.

Chancellor Rishi Sunak is expected to announce a £9billion package to help households pay soaring power bills later today.

Will raising interest rates make the cost of living crisis better or worse?

Dr. Tony Syme, macroeconomics expert from the University of Salford Business School, thinks raising interest rates will not address the real issues: “The backdrop is December’s 5.4% official rate of inflation, the highest since 1992, and it is expecting to keep rising until April when household energy bills will rise dramatically.

“If inflation is more than one percentage point away from the 2% target, the Governor of the Bank of England is required to send an open letter to the Chancellor of the Exchequer explaining why the target was missed and what action the Bank is taking to bring inflation back to target.

“But will these interest rate rises bring down inflation?

“Behind the ONS statistics, there are four common themes throughout: the exceptional rise in the price of energy, rising fuel and thus distribution costs, staff shortages due to the pandemic and Brexit, and poor harvests.

“A rise in interest rates will have no effect on any of these. These are driven by supply-side issues and interest rates are primarily a demand-side tool.

“The Bank of England has publicly stated that the reason for the increase in inflation in 2021 was the easing of Covid restrictions, and raising interest rates would be effective for this type of demand-pull inflation. But that pent-up demand has lessened considerably and it is only a small part of the reason for the current increase in prices.

“The increase in interest rates will have minimal effect on inflation and will only exacerbate the cost of living crisis. Higher housing costs will be passed onto homeowners through increased mortgage rates and onto renters as landlords pass on their increased costs of borrowing.

“And then there is the effect on credit repayments. As of October 2021, UK households had £55bn outstanding on their credit card balances. Monthly repayments on credit cards will rise and put many households into real difficulty in meeting their credit commitments if these interest rates continue to rise.

“The Bank of England is required to act, but this will only make things worse for the British population.”

Simon Massey, Managing Partner at accountancy firm, Menzies LLP, says rising interest rates could make things more difficult for businesses. He comments: “This rate rise was well trailed, but there is still considerable uncertainty about how high rates could go before the year is out. Record levels of inflation (5.4%) are making it very difficult for businesses to manage rising costs, at a time when real wages are falling, and they are facing pressure to increase salaries just to keep key employees on board.

“For entrepreneurial businesses, the rate rise is likely to impact the cost of borrowing. While the increase is quite small at the moment, further rises could make it much harder for small and medium-sized businesses to secure the finance they need to fund their growth plans.”

Effect on those with personal loans

Paul Heywood, Chief Data & Analytics Officer at Equifax UK, outlines the risks for those with personal loans. He comments: “Whilst savers will have rejoiced today over the first consecutive rate hike since 2004, the same cannot be said for those with personal loans. Equifax data shows that arrears and defaults for consumer credit and motor finance are once again starting to rise, suggesting that financial pressures amongst consumers are beginning to build up.

“When matched with the forecast that inflation will soar past its current 5.4 percent state in 2022, fuelled by energy and goods prices, there is no better time for lenders to conduct proper affordability assessments via Open Banking to protect consumers from later stage debt and extended periods of forbearance.”

Daniel Casali, Chief Investment Strategist at Tilney Smith & Williamson, also provided comment on the rate rises.

He said: “As expected by the consensus of economists and money markets, the Bank of England (BOE) raised interest rates by 25 basis points to 0.5%. This was by a 5-4 majority in favour (2 MPC members wanted to raise by 50bps) and is the first back-to-back meeting rate hike since 2004.

“The BOE also formally announced it would begin to reduce Gilt holdings by ceasing reinvestments by a 9-0 vote. The BOE said that just over £70 billion of Gilt holdings are due to mature in total over 2022 and 2023.

“The BOE decision to raise interest rates and begin Quantitative Tightening probably lies in the persistent above-target inflation readings. In the near-term, inflation risk seems skewed to the upside. The YouGov consumer survey of inflation expectations over the next 12 months hit a record 4.8% in January from data that goes back to 2005.

“Over the longer term, and with the Omicron wave abating, the BOE needs to deal with a tightening labour market and its impact on inflation. The unemployment rate at 4.1% in October (the latest data) is trending down and is not far off the pre-pandemic level of 3.8% at the end of 2019. Nevertheless, the good news on the cost-push inflation front is that whole economy wage rates are slowing against a background of firm labour demand – there was a record 1.2m job vacancies in November. This may be an early sign that inflation may not be becoming ingrained into the economy as feared by some.

“Looking forward, according to the latest Bloomberg consensus survey of economists, annual CPI inflation is expected to peak at 5.7% in the second quarter of 2022, before steadily slowing to a 3.7% clip by the fourth quarter of 2022 and below the BOE’s 2.0% target ceiling by the second quarter of 2023.

“While the inflation outlook is expected to cool, the money markets still expect the BOE to raise interest rates to 1.5% in a year’s time from now. The trade-off for the BOE will be to bring down inflation without eroding growth too much. Given growth headwinds from rising energy costs and an increase in National Insurance from April, the BOE may well take a cautious approach and not raise interest rates at its next Monetary Policy Committee (MPC) in March. Instead, the BOE may well prefer to raise interest rates at its 5 May MPC and several more times in the second half of 2022.

“For markets, BOE rate hikes, against a backdrop of solid 4% real GDP growth expected by a consensus of economists for 2022, implies that the yield curve could well steepen further. The spread between UK 10-year Gilts over 3-month T-bills is currently trading at 1.0%, up from a low of -0.4% in September 2020.

“A widening yield curve creates a positive environment for domestic banks’ net interest margins and profits. Given that UK banks relative performance has tended to follow the yield curve over the last few years, there is potential upside for this sector. The risk for investors is that rising rates stifles credit growth. Though there appears little evidence of this happening. Total Bank loan growth to the household sector rose by a historically elevated 4.1% rate from a year ago in December.”