Interest rates hit 15-year high but BoE says inflation will be 5% by end of 2023

The Bank of England (BoE) has raised interest rates for the 14th consecutive time, taking them to 5.25%, a 15-year high.

Interest rates have been increased from 5%, an increase of 0.25%, amidst concerns that cost-of-living pressures are still proving persistent. Although inflation is on the decline, dropping to 7.9% in June, it remains well above most industrial nations and is nearly four times as high as the BoE’s target of 2%.

According to independent inflation data-aggregator truflation, the real inflation rate is higher than the figure put forward by the ONS too.

The Bank of England was split three ways over the rise, with six policymakers in favour of the 0.25% rate rise, two in favour of a 0.5% rise, and one wishing to maintain the 5% rate.

Despite its latest rate increase, BoE economists are expecting underlying quarterly GDP growth of 0.2% in 2023 Q2 and Q3 and predict inflation will have dropped to around 5% by the end of this year.

Industry reaction

Chieu Cao, CEO of Mintago, said: “Another interest rate hike, another sucker punch that will leave millions reeling.

“We can be sure employers and managers are seeing the headlines about those drowning in skyrocketing debt and repayments, but how many have actually taken action to support their employees through these challenging times? In fact, how many even know which of their staff are struggling with issues such as higher interest rates and the cost-of-living crisis?

“Unfortunately, too many businesses are not having the right conversations with staff – talking about financial stress remains a workplace taboo, and people’s well-being is being harmed as a result. But now is the time to step up. There is no use pointing the finger of blame at the Bank of England, the government, banks or anyone else. Business leaders must understand the critical role they can play in supporting employees at this time – prioritising financial wellbeing over other light-touch perks and benefits is a must in the current climate.”

Ian McLennan, Partner at Triple Point Ventures says: “Today’s quarter-point raise is as expected by both investors and markets so it’s unlikely to have any immediate material impact on the venture capital/start-up world. However, the continual drip of interest rate rises without prospects of rates reversing in the next 12 months means we expect the economy to remain subdued for the foreseeable. To be honest, the venture-backed start-up market is probably more impacted by sentiment around international economies like the US, and not just the UK.

“Start-up funding is, for now, to remain bifurcated between the majority of companies which are finding it tough to raise, and the select few in hotter areas like AI, that often find VCs competing to fund them, often at inflated valuations.

“For slightly more established firms, demonstrating a robust year-on-year revenue growth rate is now more important than ever in attracting venture funding. Although, there is one notable benefit from the gradual macro-economic weakening, which is that start-ups are finding it ever so slightly easier to hire skilled engineers, sales and marketing folk.”

Kaley Crossthwaite, Partner at BDO commented: “Today’s 14th consecutive hike in interest rates will not come as a huge surprise, as the BoE and Government continue to attempt to tackle sky-high inflation. However, the speed at which these rate rises will truly impact inflation remains to be seen.

“Consumer spending has fared well despite the cost of living crisis, with banks now under pressure from the Government to pass on higher interest rates to savers. BDO’s bi-monthly survey of 500 mid-sized businesses found that many are pessimistic about the inflationary outlook, with the majority (86%) of business leaders expecting inflation to increase by the end of the year from where it is now, with almost a third (29%) expecting it to increase by more than half.

“Many expected the UK to enter recession, which we have avoided up until this point. But with higher rates having a real impact on potential business investment and growth, this continued rate rise cycle could be the catalyst that sparks the recession, albeit later than many originally anticipated.”

George Lagarias, Chief Economist at Mazars comments: “The Bank heeded the calls for restraint and hiked only once. In essence, the central bank is acknowledging that slow growth is a concern and that inflation is finally showing signs of retreat. We now have to see whether its cautious strategy will pay off, or whether a more aggressive stance will be needed in months to come.”

Joseph Calnan, Corporate FX Dealing Manager, Moneycorp, said: “Today’s decision was likely one of the BoE’s hardest yet. The Committee was facing a perfect storm, with intense pressure from opposing directions. On the one hand, July’s slight drop in inflation, the threat of recession and concerns for households and businesses, but on the other, the imperative to finally get inflation down to 2%.

“While we’re likely now looking at a lower terminal rate than forecasted a few weeks ago, we can’t yet say whether a shallow hike was too dovish too soon. August’s CPI data will give us an early sense, but the reality is the policy decisions of recent months will take far longer to make themselves felt.

“Even if inflation continues to drop, every decision the Bank makes for the next two years will be pivotal in determining how quickly we get our economy back on track.”

It takes at least nine quarters for interest rate changes to impact inflation

University of Salford Business School’s Dr Tony Syme, Senior Lecturer in Economics and Head of the Finance and Economics subject group, explains how long it takes for interest rate rises to impact inflation.

He says:“For the 14th consecutive time, the Bank of England raised interest rates today. As if taken from a Macroeconomics textbook from the 1950s, the Bank of England is adjusting the economy’s ‘thermostat’ and inflation will be controlled. But this is not the 1950s. It is not working.

“Even if today’s interest rate hike was effective, it would not bring inflation down next month. The issue is the ‘transmission mechanism’, the channels by which an increase in the Bank’s interest rate impacts the economy.

“According to their own research, when the Bank of England raises interest rates, it takes nine quarters before the full effect on inflation is achieved. In other words, today’s interest rates will have their biggest impact on inflation in October 2025.

“And since that research was published in 1999, there has been wide acceptance that these time lags in monetary policy have only grown longer due to the rise of fixed-rate mortgages.

“According to UK Finance, 800,000 fixed-rate mortgages will expire by the end of this year and a further 1.6 million fixed-rate mortgages will expire next year.

“The rise of fixed-rate mortgages also means that these interest rate rises have had little impact on households for months at a time, and then, when the fixed-rate mortgage expires, the impact on household finances will be devastating.

“A recession is imminent and as the inverted yield curves show, this will be a recession most deeply felt in Europe and North America. These are the regions in which central banks have raised interest rates month after month.

“Families will suffer the double pain of job losses and the continuing impact of these interest rate rises. That is a heavy price to pay for economic mismanagement.”