Interest rate reaches 0.75% as Bank of England looks to combat rising inflation

The Bank of England (BoE) has raised its interest rate by 0.25 percentage points to 0.75%, meaning it now stands at its pre-pandemic level. However, the BoE warned rising inflation will intensify this autumn after Russia’s invasion of Ukraine added to the pressure on energy prices.

Inflation is expected to hit 8% next month, but the bank said instead of peaking in April, the rate of consumer price increases is forecast to hit an even higher level in October that could be “several percentage points” above what was expected last month.

The rise in inflation expected in April is driven by the 54% rise in Ofgem’s energy cap, which is set to come in that month. However, Russia’s invasion of Ukraine has driven wholesale prices even higher, meaning bills could rise a further 35% when the cap is reset in October, according to the bank’s monetary policy committee (MPC).

Industry reaction

Serial entrepreneur and investor Neil Debenham said: “Russia’s invasion of Ukraine has caused the already precarious world economy to face even greater instability. The current war has sent shock waves across financial markets, resulting in rising energy prices and causing inflation to soar to new heights.

“With oil prices surging to over $100 a barrel for the first time since 2014 and inflation now at a 30-year high, the Bank of England has now increased interest rates for the third time in three months.

“The Bank of England knows the rising cost of living has to be managed in the short-term. The added market uncertainty spurred on by instability in Eastern Europe could place additional financial pressures on consumers and businesses already feeling the squeeze, particularly when it comes to energy prices.

“Raising the rate of interest does have consequences, however. Theoretically, a hike should reduce inflation, but curb consumer spending. However, given the current market uncertainty, it is difficult to assume a modest rise will have any immediate or prolonged impact on the economy. With the country keen to progress pass the pandemic, the last thing anyone wants is the risk of a global economic recession at this precarious time.”

According to Director of Henry Dannell, Geoff Garrett, further rises in the interest rate are likely too.

He comments: “A hat trick of base rate increases was largely expected, but this latest jump has probably come a little sooner than planned, though it’s not come as a huge surprise given the climbing rate of inflation. There was a slight change of sentiment within the MPC (Monetary Policy Committee) compared to February, with the overall approach becoming slightly less hawkish.

“We are now back to the pre-pandemic interest rate, so there’s certainly no reason for immediate panic. However, it’s more than likely we will see the base rate continue to climb, settling at 1% to 1.25% by the end of the year.

“This will, of course, mean that many homeowners will see their monthly mortgage cost increase, which will add additional financial pressure to the already increasing cost of living.”

Is the Bank of England’s long-term thinking correct?

Dr. Tony Syme, macroeconomic expert from the University of Salford Business School, questions the long-term thinking of the Bank and says that the decline in real wages being felt across the country, as well as increasing prices, will work to bring spending down anyway.

He comments: “As the Bank of England say, ‘higher interest rates makes borrowing more expensive and it encourages saving. That reduces how much people spend overall. And this will help to keep inflation down’. But the decline in real wages and increasing pressure on household budgets is already reducing how much people spend anyway.

“The issues in the labour market should be the focus of government policy. For the Bank of England, they should take their lead from A.A. Milne: ‘Doing nothing often leads to the very best of something’.

“There are clear signals that there will be several more interest rate rises this year. The policy is designed to limit inflation which reached a 30-year high in January at 5.5%.

“But there is an inherent flaw within this policy. As the Bank of England say themselves, ‘higher interest rates don’t work straight away. They take time to take full effect. So, when we use them, we always look at what will happen in the economy in one or two years’ time, not just what’s happening now’. And yet the same statement also says that ‘most of the current causes of the current high rate of inflation won’t last’ and ‘we expect it [inflation] to be much closer to our two percent target in two years’ time’.

“The rate of increase in energy bills and petrol should certainly slow over the next two years, but there will be a ratchet effect. Whenever world oil prices go up, there is a corresponding rise in prices at the petrol pump. But we never see the same reduction in prices when world oil prices fall.

“The IFS reported that the 2010s had been the worst decade for real wage growth since the Napoleonic Wars. With the ONS reporting this week that real wages fell by the highest amount since 2014 and an increase in national insurance contributions by 1.25% is set to be confirmed by Rishi Sunak next week, it is clear that the current pay squeeze is likely to make this decade even worse for living standards than the last one.

“The Bank of England is worried about the high level of vacancies in the labour market, a measure of ‘tightness’ that may lead to employers raising wages to fill these vacancies. But the cause here is the reduction in the labour force. As the Institute for Employment Studies highlights, ‘there are now 1.1 million fewer people in the labour force than we would have expected based on pre-crisis trends’. Most of that is due to the over-50s withdrawing from the labour market, but due to a combination of Covid and Brexit, many EU nationals who worked in the UK have also returned to their countries of origin.

“According to the IFS, the increase in vacancies has ‘been driven entirely by low-paying occupations’ with the health and social care industry having the highest number with 210,000 unfilled vacancies. These are the occupations that can least afford the rise in the price of food, utilities and petrol.”

The wrong metrics?

Sarah Walker-Smith, CEO of law firm, Shakespeare Martineau and professional services group, Ampa, says we need to look at different metrics to have a positive impact on growth.

She comments: “The blunt instrument of interest rate hikes and the two percent inflation rule no longer serve us. Instead, our metrics need to shift to prioritise growth measures.

“Rather than controlling spending through interest rate hikes, we need to incentivise confidence and investment. It’s a complex supply issue, not a demand issue. Fixing the challenges around energy, workforces and supply chains must be top of the priority list.

“A cocktail of measures is needed to solve supply-side problems. By encouraging digital investment and boosting Government support for the rapid development of skills in high-demand areas, we can revive dying sectors.

“Co-ordinated regeneration is core to achieving this. We need to bring our city centres back to life, improve co-operation between businesses, banks and the Government, and refresh our talent pool. Joined-up policy, intelligent investment and a spirit of collaboration are the way out of this.

“Raising interest rates will result in another push into recession. It will hit those in lower-paid jobs, and those facing the worst of the cost-of-living crisis, the most. In turn, it will further empty Government coffers at a time when it is seeking to reduce the deficit built up over the last two years.

“We need to look at the bigger picture. Unless we solve the UK’s wider economic and societal problems, no amount of interest rate rises will help.”

Not a surprise

However, Dr Maria Rana, economic expert at the University of Salford Business School, is not surprised by the Bank of England’s decision.

She says: “With inflation and the cost of living expected to increase even further in the second quarter of the year, after reaching a 30-year record high of 5.5% in January and expected to increase even further to more than 7% in April, the decision does not come as a surprise, being an attempt to control the increase in the general level of prices.

“Let’s be also reminded of the fact that the BoE was the first major central bank to start increasing interest rates in December 2021 since the hit of the pandemic, with the main concern also at that time on how far it would go and if it was the end of low-interest rates.

“There is a lot of uncertainty now, related to the invasion of Ukraine, with consumer and business confidence likely to be affected. This is why one member of the committee did not vote for an increase but for rates to stay the same.

“Those who will be mostly and immediately affected by the increase in the cost of borrowing are homeowners on mortgages with variable rates and those whose fixed-rate mortgages are coming to an end and have to renegotiate. And clearly, those applying for new mortgages (anticipating the rise, major commercial banks have started to increase the rates before the first increase by the BoE in December 2021).

“The increase in interest rates is good news for those with saving accounts, but those on the lowest incomes who rely on loans for consumption, even more after the pandemic, will once again sadly pay the highest price.”