Costly credit and a mortgage timebomb: five ways rising interest rates have hit the UK | Bank of England

Two years ago, Britain’s economy was entering an uncertain winter. The Omicron variant of Covid-19 was hitting businesses hard. Furlough had ended. Inflation was at a 10-year high of 5.1%.

Against this backdrop – two years ago this week – the Bank of England took its first tentative step to raise interest rates from 0.1% to 0.25%. A month earlier, the Bank had ducked a decision to raise rates given concerns over the end of the government’s furlough scheme, wrong-footing financial markets. Few predicted how far Threadneedle Street would go next.

Among independent forecasters, the average inflation reading expected for the end of 2022 was just 3.1% – nowhere near the 11.1% peak in October 2022 that resulted after Russia’s invasion of Ukraine.

After 13 more increases after its first move in December 2021 – lifting the base rate to 5.25% by August 2023, the highest level since the 2008 financial crisis – the Bank is expected to leave borrowing costs unchanged for a third consecutive time at its next meeting on Thursday. While inflation remains above the Bank’s 2% target, having fallen back to 4.6%, concern is growing over the strength of the economy after the toughest round of rate increases in decades.

Here are five ways that households and businesses are feeling the pinch:

Mortgages

The driving-up of interest rates at the sharpest rate in the 26-year history of the Bank’s monetary policy committee has primed a ticking timebomb in the UK’s mortgage market.

Most home loans taken out in recent years have a fixed rate – meaning higher borrowing costs tend to come with a lag. About 55% of mortgages have repriced since rates started to rise in December 2021. Another 5m are expected to be hit by 2026.

For the typical owner-occupier rolling off a fixed rate between the summer of this year and the end of 2026, the Bank expects their monthly repayments to increase by about £240, a jump of about 39%.

Many landlords have raised rents or sold properties to offset their own higher borrowing costs. Given limited supply, renters have faced a surge of more than 10% in annual rental inflation on new lets.

Credit cards

High street banks are passing on the rise in interest rates to borrowers who use credit cards and personal loans – adding to the pressure on households struggling to make ends meet amid the cost of living crisis.

Annual growth in all consumer credit was 8.1% in October, the fastest pace since 2018. Average quoted rates on credit cards have risen by about 5 percentage points to 25% in the past three years.

Overall household debt levels are at the lowest point since 2002, but this reflects a falling number of households with mortgages. With soaring living costs, more than 24 million UK adults – 40% of the population – plan to use credit to pay for Christmas gifts this year.

Savings

High street banks have been slower to pass on higher interest rates to savers – exposing them to accusations of profiteering from trade unions and MPs from across the political spectrum. Meanwhile, many households are raiding their savings to pay for the higher price of basic essentials.

Recent figures from the Bank show average quoted rates have belatedly started to catch up, with an increase of about 0.9 percentage points for instant access deposits between June and October after the Financial Conduct Authority set out an “action plan” to ensure higher rates are passed on.

However, significant differences remain. While some accounts offer above the Bank’s base rate of 5.25%, the average rate on easy access deposits was 1.99% in October, according to the latest figures from the FCA, or 3.52% for fixed-term accounts.

Business lending

The interest rate on new bank loans for businesses has leaped from about 2% at the start of the tightening cycle to almost 7% today, while many firms have reported a decline in credit availability.

Under pressure from weaker consumer demand and rising borrowing costs, the number of company insolvencies has jumped in recent months – hitting 2,315 in October, 18% higher than in the same month a year earlier. Companies in the construction sector are faring the worst.

The Bank expects rising interest rates are likely to contribute to a reduction in business investment growth. A key priority of the government is to raise investment in Britain, but higher interest rates are serving as a headwind.

Market interest rates

Increases in UK interest rates relative to other countries’ rates would normally cause the pound to appreciate on global currency markets. However, the Bank’s tightening cycle has been matched by other leading central banks. That said, if Threadneedle Street had not acted, sterling could have fallen significantly, adding to inflation by driving up the cost of imported goods.

Reflecting the actions of central banks, stubbornly high inflation and weaker economic growth, government bond yields have increased sharply across advanced economies. The cost of issuing bonds for large corporates has also risen.

City investors are betting the central banks’ next move will be to reduce interest rates. With inflation fading and a growing risk of recession, financial markets expect the Bank to launch its first rate cut from as early as summer 2024.