Interest rates jumped to 1% on Thursday - the highest level for 13 years and the fourth increase since December, as the Bank of England battles to cool rocketing inflation.
The Bank's policymakers voted to raise rates from 0.75% to 1% - a level not seen since early 2009 - as the Ukraine war compounds a crippling cost-of-living crisis.
The fourth rise since December 2021 comes as soaring food, energy and fuel prices saw inflation - the measure of the rising cost of goods - hit a 30-year high of 7% in March. Today, Threadneedle Street said inflation is likely to be at 10% by the end of the year.
The base rate is the interest rate that the Bank of England charges commercial banks for loans and until now stood at 0.75%.
The change means higher mortgage payments for more than two million homeowners with variable rate mortgages.
It would also increase the cost of other loans, cutting what consumers have available to spend elsewhere.
Those who are saving money would see higher interest payments - but it can take some time for bank rate changes to be passed on to consumers. Even if it was passed on immediately, it would quickly be wiped out by the 7% rise in the cost of living.
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The cost crunch is expected to tighten its grip later this year when the energy price cap is revised once again, with warnings inflation could peak at 9% or even double digits in the autumn.
Governor Andrew Bailey recently warned the Bank is "walking a very tight line" between tackling inflation and avoiding a recession. The bank's aim is to keep inflation as close to 2% as possible.
Investec economists said: "The UK is in the grip of the cost-of-living crisis. Coupled with tax rises, this leaves a rocky road ahead."
They expect that a recession will be averted, thanks in large part to the savings built up by households in the pandemic, but said slowing growth and soaring inflation "leaves the MPC in a bind".
Investec is pencilling in another rate hike in August to 1.25%.
But it sees the Bank pausing after this "to assess how big the effect of the real income squeeze on activity turns out", before pushing through two more rate rises in 2023.
Growth already began to pull back sharply in February as the cost-of-living squeeze took hold, with official data showing expansion of just 0.1% down from 0.8% in January.
Alice Haine, at investing platform Bestinvest, said: “Any decision to increase rates has to be approached very carefully, with Bank Governor Andrew Bailey needing to address not just the toxic mix of slowing growth and high inflation – known as stagflation – but also the struggles faced by consumers during the cost-of-living crisis.
“Inflation hit a 30-year-high of 7% in March – with the fear that increasing rates too aggressively will slow the economic recovery from the Covid-19 pandemic at a time when the fallout from the Ukraine conflict with Russia is hitting households hard through higher energy and food prices.
"Add in higher taxation, thanks to a combination of the April increase in National Insurance rate and frozen pension allowances, and household personal finances are starting to creak under the strain of escalating costs."
Savings
Banks were painfully slow in passing on the last three rate rises to savers. Even if they did so overnight, a 1% increase in interest would still fall massively below inflation at 7%. That means any gains would quickly be wiped out.
That said, if you do have savings, you need to stash it somewhere, so it's worth keeping an eye on the best buys in the coming weeks.
Top easy-access accounts are paying as much as 1.5% right now. Chase, a JP Morgan owned bank, is paying 1.5% on up to £250,000 while Gatehouse Bank is paying 1.3% on up to £250,000, but the minimum amount you have to pay in is £1,000.
Some savers may choose to invest instead, or use their money to pay off debts, loans or make an overpayment on their mortgage if the interest on that has gone up.
Rachel Springall, finance expert at Moneyfacts.co.uk, told The Mirror: “Loyal savers who have an easy access account with one of the biggest high-street brands are seeing little benefit from base rate rises, as many of these brands have passed on just 0.09% since December 2021 and none have passed on all three base rate rises, which equate to 0.65%*.
"The average easy access rate has risen by 0.20% since the start of November 2021, so there is still room for improvement across the sector, but as rates rise, comparing deals and switching is wise.
"As we have seen before, it can take a few months for customers to see any benefit from a base rate rise but there is no guarantee that savings providers will increase their rates."
Should savers see 0.25% passed onto them, it would mean receiving £50 more a year in interest based on a £20,000 investment.
Ms Springall added: “The top rate tables for easy access accounts are experiencing some rivalry from challenger banks, which is great news for savers who prefer to keep their cash close to hand. If savers are using easy access accounts as a safety-net, they must check that they will not get penalised for withdrawals and ensure it’s still offering a competitive return."
Mortgages
Around 2million homeowners on standard variable (SVRs) and tracker rate mortgages will almost certainly be affected by today's rate rise as these mortgages ‘track’ the Bank of England base rate.
If you’re on an SVR, the latest rise could add an extra £347.50 to annual mortgage payments based on a rate of 4.78% and a 25-year £200,000 mortgage.
Coupled with the last three increases, it means homeowners will now be paying around £1,313 more a year.
A fixed rate mortgage could provide a safe haven against the rise as it locks you in a deal for a set term - but you'll have to act fast as these have been rising steadily since December. The good news is interest rates are still historically low.
The difference between the average two-year fixed mortgage rate and SVR stands at 1.75% - a difference of approximately £4,611 over two years, again based on a 25-year £200,000 mortgage at 4.78%.
A mortgage broker can help you find the most suitable deal for your circumstances and factor in true costs. It’s important to not only think about headline rates, but also assess any additional fees that may be involved
But for the 3million people with fixed deals expiring mid-2022 and beyond, watch out for any early repayment charges.
You'll need to weigh-up whether paying an exit fee to remortgage early is financially worth it.
Ultimately, your mortgage is based on how much of your debt is still outstanding. So with interest rates still very low on savings, it might be worth considering paying off some of your debt in the form of an overpayment. Check the small print on this - most lenders will let you overpay by around 10% a year fee-free.
Amanda Aumonier, head of mortgage operations at online mortgage broker Trussle, said: “Homeowners are under incredible financial pressure and this interest rate rise will only add further fuel to the fire in the short term.
"It is crucial that homeowners understand their options.
"We would urge anyone approaching the end of their mortgage term to speak to a broker. Our research shows remortgaging can save homeowners £4,000 per year."
Rachel Springall, finance expert at Moneyfacts.co.uk, told The Mirror: “Borrowers sitting on a variable rate may want to lock into a competitive fixed rate mortgage deal to protect themselves from rising interest rates, perhaps sooner rather than later as fixed rates rise, with the average two-year fixed rate surpassing 3.00%.
“Fixing for longer may be a logical choice for peace of mind."
First-time buyers are also likely to be affected.
Vadim Toader, at equity lender, Proportunity, said: "We’ve already seen mortgage lenders removing cheaper rates in anticipation of the rise, despite house prices increasing at the fastest rate in 17 years.
"Novice buyers need to prepare themselves that interest rates will likely go higher. As a result, they may need to increase their deposit and explore other lending options, to lower their loan to value and access better rates."
Loans and debt
Most personal loans are based on fixed rates, so if you have unsecured borrowing you should continue to repay it as agreed.
Some credit card rates are variable, but not typically explicitly linked to the base rate, so won’t automatically go up. If you're on a fixed rate credit card, it's worth checking the time period left on it. When it ends, you might find yourself on a variable rate, so make a note of it.
Neil Kadagathur, chief executive of Creditspring, said: ““We’re in danger of creating a generation of people for whom spiralling debt is simply a fact or life. Amongst 18-34 year olds, a third will have to borrow to survive the next few months – this figure will soar in the coming months unless more effective support is offered to the most vulnerable households. Borrowing is set to become more expensive, disproportionately hurting lower-income households and borrowers."
Why do interest rates go up?
Central banks, like the Bank of England, have tools to help them shape the country's economy.
One of these is base rate, a kind of super interest rate which all other financial firms tend to pay attention to.
Raising or lowering this rate helps control the growth of the economy, and therefore inflation.
Inflation erodes the spending power of money, and the theory is that raising the base rate brings this under control by making it more expensive to borrow.
But how does raising the base rate bring down inflation?
When the base rate is high, borrowing money becomes expensive. If a mortgage charges 2% interest and the base rate goes up by 1%, the exact same mortgage will start charging 3% instead.
When this happens consumers and businesses are more likely to save and not spend, which slows the economy down and brings inflation down with it.
When the base rate is low, borrowing is cheap - but savings rates are low, which means we are more likely to spend and not save. This means the economy grows quickly, but can mean inflation spikes.
