The Bank of England chose to hike rates again on 2 February 2023 by 0.5%, bringing the headline base rate to 4%.

The hike brings the base rate to its highest level since November 2008 – and marks ten consecutive hikes since January 2022. The bank has hiked rates to a 14-year high thanks to rocketing inflation which has taken hold of the UK and the global economy in the past 18 months.

Inflation has soared thanks to a mixture of factors including the reopening of the economy after more than a year of COVID-19 related lockdowns, which caused global supply chain issues. Unlocking the economy also unleashed pent-up cash held by people who were unable to spend on things like eating out, holidays and other out-of-home items. Inflationary pressures were then severely exacerbated by Russia’s invasion of Ukraine, which triggered an energy crisis across Europe which filtered out into the rest of the world.

Why has the Bank of England hiked again?

The latest inflation data from the ONS suggests that we might have reached a peak for accelerating price rises. October 2022 saw CPI inflation hit 11.1%, but this has waned slightly, down to 10.7% in November and 10.5% in December.

While these falls are small, they do give a small amount of hope to the economy that pressure might be beginning to ease. However, the Bank of England has maintained its policy of hiking rates despite this easing. There are a few reasons for this. Firstly, the jobs market remains really robust, with little signs of rising unemployment. This sustains demand and can help to keep prices rising more strongly than otherwise. Secondly, wage rises are still relatively strong. Although on average workers are not getting pay rises that beat inflation – currently 6.4% for regular pay – this is still relatively high in historic terms. Like employment this means that inflation overall could prove to be ‘stickier’ than otherwise as people’s pay packets are boosted.

Finally, core inflation – which measures less volatile segments of price rises – remains relatively high. This measure excludes volatile prices such as food, energy, alcohol and tobacco. Both core and services inflation rose in December, despite the headline fall. This tells the Bank of England that important parts of the economy are still experiencing rising demand and a shortage of provision for that demand – the basic cause of inflation. The Monetary Policy Committee (MPC) will have looked at these factors to decide where it should go with its base rate, and this is why it has chosen to continue hiking.

Where next for rate hikes?

The Bank of England has kept its cards fairly close to its chest on what it will do in subsequent months this year in the face of inflation. Much depends on changing economic conditions. For its forecast, it sees the UK economy entering a shallower recession than previously estimated, which would suggest it expects rates will have to stay higher for longer to tame price rises. Ultimately, the Bank of England has a mandate to bring inflation to a level of 2%. As long as inflation persists at higher levels, it could be drawn to more hikes to temper the economy.

However, looking at important factors in the current inflationary mix suggests that price rises could soon fall quickly. Energy prices have come way down from their wholesale peak in June 2022. While it takes time for this to feed through into the wider economy and ultimately our bills, energy has a big influence on prices as almost all businesses need to use energy to provide the goods and services they offer, while households are reliant on it to run their own homes.

What does this mean for your finances?

Higher interest rates have a number of effects on personal finances and wealth. The most obvious is higher debt costs. As the Bank of England hikes rates, financial firms are obliged to raise the interest they charge for borrowing. This includes everything from mortgages to loans and credit cards.

Mortgages are the most obvious place where rates visibly rise. However, most households are on fixed rates. Those households that are facing coming off their fixed rates this year are likely to see their monthly payments soar if rates continue to persist higher. After the disastrous mini-budget of October last year, some of the so-called ‘moron premium’ added to average rates has come down slightly. However, rates are still higher than they might have been.

Another important area that is affected is savings and investments. Savings accounts are offering better rates than previously, but largely still well below inflation. This means that while a savings account might provide a much better headline rate than in the past, it still isn’t preserving the value of that money.

Investments had a tough year in 2022 as they adjusted to the new conditions. However, higher rates offer opportunities in new areas such as the bond market which now has attractive valuation levels. Equities have also had a stronger start to 2023 as markets have priced in some of the worst effects of rate hikes.

If you would like to discuss this or anything else not mentioned in this article, don’t hesitate to get in touch.

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All the data contained in the communication is believed to be reliable but may be inaccurate or incomplete. Unless otherwise specified all information is produced as of 13th February 2023.