BoE raises interest rates to 1.75%: what this means for borrowers and savers

Alice Haine, Personal Finance Analyst at Bestinvest, the DIY investing and coaching service, says the half-point hike in the benchmark lending rate marks the sixth increase in a row and takes the base rate to the highest level since the global financial crisis.

“This is biggest interest rate rise since February 1995, with the move effectively taking money out of people’s pockets by increasing borrowing costs as the Bank of England looks to curb the worst bout of inflation in 40 years.

“The Monetary Policy Committee’s 8-1 vote in favour of the 50-point hike is a dramatic pivot for the BoE after more than a decade of easy money, with the aim to ease inflation back down towards the 2% target, while taking interest rates to more normal levels.

“While it is unusual for a central bank to raise rates when the economy is in danger of falling into a recession, the country is in the grip of a cost-of-living crisis as global challenges such as Ukraine’s war with Russia drive up food and fuel prices to dizzying highs.

“The BoE said it expects inflation to hit more than 13% in the fourth quarter and persist at ‘very elevated levels’ during much of 2023, proving the Central Bank had little choice over its more aggressive monetary policy decision. With labour shortages prevailing and companies continuing to dish out bumper pay rises that still fail to keep pace with runaway inflation, there will be little respite for households for some time to come.

“The latest interest rate rise will also eat into the Government’s package of handouts to support struggling households. Up to eight million vulnerable households are in line to receive £1,200 in Government aid this year to help them cope with the huge financial hit delivered by the cost-of-living crisis, including the £326 support payment issued last month.

“Rampant inflation will only fuel the war of words over tax cuts between the Tory contenders battling it out to replace Boris Johnson. Rishi Sunak will use the BoE’s inflation warning to suggest that now is not the time for the scale of tax cuts proposed by Liz Truss as putting more money into people’s pockets will only send prices even higher.

“But with energy bills set to hit new highs in October, whoever wins will have a difficult balancing act to perform if they want to lower inflation, boost growth and ensure households stay solvent through the long winter months.”

“A higher base rate means more misery for households. While mortgage rates are low by historical standards, nobody wants an increase in payments during a cost-of-living squeeze.

“Recent BoE data showed the effective interest rate on new mortgages hit 2.15% in June – this will only go up putting those already struggling to balance the books at risk of a major mortgage shock.

“Of course, not every mortgage holder will be affected straightaway. Most mortgages are fixed, so the lucky ones that locked themselves into five or 10-year mortgage in the past couple of years can sit back and relax for now.

“But for homeowners with rates expiring this year, the picture is less rosy. The best strategy is to lock in a new fixed-rate deal now as lenders allow borrowers to secure a rate up to six months in advance of the deal starting.

“For those on tracker mortgages, where the home loan tracks the BoE base rate, the base rate increase will be instantly passed on to borrowers in full delivering an immediate financial hit. Therefore, switching to a fixed-rate offer would be a sensible move.

“The same applies to borrowers on a standard variable rate, something borrowers go onto after finishing an introductory fixed, tracker or discounted deal. They could also see their mortgage rise if their lender feeds that increase back to customers so make the switch while you can.

“For anyone with a mortgage set to expire next year, overpay now to reduce the hit when the renewal date comes around. The more capital you have paid off, the less of a blow a rise in interest rates can deliver.

“The worrying effect of higher mortgage payments is that people have less disposable income to spend at a time when household finances may already be stretched thin.

“Higher rates also translate into more expensive loans, credit cards and overdrafts if banks pass on the increased rate, a concerning factor when it is likely more households will use credit to pay everyday expenses during the costs crunch. The jump in consumer credit borrowing to £1.8bn in June from £0.9bn in May proves just how challenging the current environment is already becoming.

“Those locked into a fixed-rate personal loan or car loan won’t have to pay more as the terms have already been agreed, but new borrowers shopping around for credit will find the cost of debt higher.

“Anyone with niggling credit card debt could consider a 0% balance transfer deal, which gives you an interest-free period to pay back the debt at your own pace without the fear of the debt compounding out of control.

“For bigger debts, such as large overdrafts or multiple maxed-out credit cards, consolidating them into a loan with one fixed payment a month should ease the stress that can come with heavy liabilities. The ultimate aim in these constrained times is to borrow as little as possible over the shortest time possible to secure the lowest rate possible.”

“An interest rate rise might seem like good news for cash savers, as higher rates deliver higher returns on any cash pots stashed away. But with the BoE expecting inflation to hit more than 13% later in the year and stay high for most of 2023, the real returns on cash will be deeply negative.

“The combination of higher mortgage rates and rising inflation means disposable income will take a double hit making saving a luxury afforded by the very fortunate.

“For those that do want to cash in on rising saving rates, every penny in additional interest is a bonus when high inflation is eating away at the purchasing power of incomes. So, shop around for the best deal.

“While banks and building societies are quick to apply higher rates to debt, they can be slower to deliver the good news to savers. However, saving rates have been creeping up to the highest levels seen in a decade, with some easy access accounts offering up to 1.71% and fixed-rate accounts that lock cash away up to 3.22% with this only set to go higher.

“Having an emergency fund is the new must-have accessory for those that want to emerge from the long winter months financially intact. An emergency pot of cash covers short-term needs such as unexpected household costs, with the general advice to have at least three to six months of expenses tucked away.

“Whether this cost-of-living crunch will be short or long, it highlights how key sound financial planning really is. Getting to grips with your money should not be a side-show in your life, it should be the main event.

“Those with longer-term horizons – more than five years and ideally at least 10 – might want to consider investing in the markets as an inflation-busting strategy. While higher returns from the markets can never be guaranteed, a long-term approach allows a diversified investment portfolio to absorb the highs as well as the lows and deliver better growth over the long term.”