Interest rates in the UK hit their highest level since 2009 but will this worsen the cost of living crisis?

Interest rates in the UK have hit 1%, their highest level since 2009. This is the fourth consecutive increase since December as the Bank of England tries to stem the rising cost of living.

The Bank’s Monetary Policy Committee (MPC) – which sets interest rates – predicted inflation would also hit 9% in the coming months – they previously forecasted it would hit 8% – and surpass 10% by the end of the year. Inflation is currently rising at its fastest rate for 30 years.

In an article posted by the BBC, the MPC was quoted as saying inflation had ‘intensified’ following the war in Ukraine.

“Global inflationary pressures have intensified sharply following Russia’s invasion of Ukraine. This has led to a material deterioration in the outlook for world and UK GDP growth,” the MPC said.

The MPC also now expects the UK economy to contract by 0.25% in 2022, down from its previous forecast of 1.25% growth, slashing its growth outlook for 2023 to 0.25%, down from 1%.

“UK GDP growth is expected to slow sharply over the first half of the forecast period,” the MPC added. “That predominantly reflects the significant adverse impact of the sharp rises in global energy and tradeable goods prices on most UK households’ real incomes and many UK companies’ profit margins.”

Will this worsen the cost of living crisis?

The cost of living crisis has seen the cost of fuel, energy and food hit incredible levels, putting a real squeeze on families, especially those falling into the lower-income brackets. However, Dr Tony Syme, macroeconomic expert from the University of Salford Business School, says the increase, from 0.75% to 1%, will not help the cost of living crisis.

He comments: “Living standards are now being eroded by inflation and the policies to address it will only make the living standards crisis even worse.

“The latest rise comes a day after the Federal Reserve announced the largest increase in interest rates since 2000 and two days after the Reserve Bank of Australia raised interest rates for the first time in more than a decade. They all cite the same reason: rising inflation.

“But that pursuit of the stable prices is likely to have serious consequences on a British economy that is fundamentally unbalanced. The Bank of England is only making matters worse. It should focus on coordinating with the Treasury to boost business investment and raise productivity. That will help to raise living standards and keep domestic inflation low in the long run, while changes to government policies around skills training and migration could tackle the current labour shortage in the short run.

“A rise in living standards is driven by rises in productivity and these are sustained by business investment. But the latest figures for business investment show that it is still 8.6% lower than it was in 2019 and, following a survey of its members, the British Chambers of Commerce recently revised downwards its projection for business investment growth in 2022 by over 30%.

“Without investment to drive forward permanent increases in productivity and, in the absence of any other supply-side factors to boost the British economy, living standards can only increase via short-term boosts to demand via trade, household consumption and government expenditure.

“While Brexit has had a negative impact on the UK’s trade balance, it has been the maintenance of household consumption throughout the pandemic and the very large rise in government expenditure that has created the growth in the economy in recent times.

“Interest rate increases raise the cost of borrowing for both households and businesses. Reductions in household spending have a negative effect on the economy in the short run. Reductions in business investment have a negative effect on the economy in the long run.

“Little wonder that the GfK Consumer Confidence index is now -38, the second-lowest reading since records began almost 50 years ago, and the Institute of Directors’ economic confidence index fell from -4 in February to -36 in April.”

What’s more, Sam Lawson, VP Capital Markets, Crowdcube, believes the interest rate rise could have significant consequences for small businesses.

He comments: “It’s not just central bankers that are walking the proverbial tightrope right now. Many small businesses are already feeling the impacts of higher inflation on revenue and budgets; moreover, this is against the backdrop of a pandemic from which many firms have only just recovered, in a lot of cases with the burden of higher borrowings.

“While today’s move may be appropriate to tackle inflation, it’s not without substantial risk. Any further rate rises must be made more gradually and with surgeon-like precision. Too rapid a tightening cycle could well be ‘the straw that broke the camel’s back’ for many small businesses – indeed invalidating the massive financial sacrifices made during the pandemic to keep them standing.”

Gary Smith, General Secretary at GMB, believes today’s decision to raise interest rates again will further compound the damage done to the economy.

He comments: ““The Bank of England’s announcement on interest rates is all pain and no gain and will only help push the UK closer to recession. GMB warned this would happen. This doubling-down on further rate rises will increase costs on homeowners, hit jobs and stifle business investment. Once again, the working people of this country will pay the price.”

enewsletter