Bank of England raises interest rates to 1.25%: what this means for mortgages, savings, debt and investing

Alice Haine, Personal Finance Analyst at Bestinvest, the DIY investment platform and coaching service, says the 0.25%-point hike in the benchmark lending rate marks the fifth increase in a row and takes the base rate to the highest level since January 2009 when the central bank was slashing borrowing costs at the height of the global financial crisis.

“While the move was less aggressive than the US Federal Reserve’s 75 basis point rate hike – its biggest interest rate rise since 1994 - the Monetary Policy Committee’s 6-3 vote in favour of the quarter point hike reflected their mandate to get inflation back down towards its 2% target in the medium-term. However, with three members of the MPC voting for a bigger hike of 0.5%, it reflected a hawkish stance for the future with the potential of more rate rises to come.

“The latest interest rate rise will eat into the Government’s recent handout to support struggling households. Chancellor of the Exchequer Rishi Sunak pledged to give up to £1,200 to eight million of the most vulnerable households to offset the “acute distress” many are facing. This includes the £400 set to be made available to everybody later in the year to ease escalating energy bills, while pensioners will also receive another £300.

“Households are struggling to keep a grip on their finances in the face of soaring food, fuel and energy bills, as well as higher taxation thanks to a combination of the April increase in National Insurance rate and frozen pension allowances. In addition, with sterling hitting a two-year low against the dollar, their pounds have not gone as far when they travel overseas on holiday.

“It means any decisions to increase rates further are difficult for the MPC and Bank Governor Andrew Bailey. Stagflation presents a difficult enough quandary – as flatlining growth would normally demand lower rates, not the higher rates that surging inflation is forcing the MPC into. But their decisions will also impact the struggles faced by consumers during the cost-of-living crisis.

“With the country already grappling with the highest inflation in 40 years and the situation set to worsen when the Ofgem price cap rises to £2,800 in October, it is no surprise that the BoE expects inflation to peak at 11% in the fourth quarter - more than five times its target of 2%. Therefore, any interest rate hike had to balance against the risk of accelerating the economic slowdown any further and tipping the UK economy into recession.”

“A higher base rate means mortgage rates will rise, adding yet another challenge for people trying to balance the household books.

“While most lenders will pass the rate rise onto borrowers, interest rates are still very much on the low side when you look back over the past 30 years or so. However, the cost-of-living crisis the country is facing right now means every pound matters as households strive to meet their monthly bills.

“The only silver lining in the latest base rate rise is that it will not affect every mortgage holder straightaway because the majority of mortgages are now fixed. The challenge comes, however, when a fixed-rate mortgage comes to an end.

“For those set to expire this year, it would be wise 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. Those with more time might consider overpaying on their mortgage to soften the blow of a higher mortgage cost further down the line. Alternatively, paying down debt or adding an extra monthly sum to their emergency fund would also strengthen their financial reserves against the myriad of challenges ahead.

“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 certainly makes sense, particularly with rates likely to go up even more in the months to come.

“Borrowers on a standard variable rate, a mortgage borrowers go onto after finishing an introductory fixed, tracker or discounted deal, could also see their mortgage rise if their lender feeds that increase back to customers. Therefore, again, considering a fixed-rate deal would be a sensible move if rates end up hitting 3%, as expected, by the end of this year – avoiding a financial shock further down the line.

“For cash savers, an interest rate rise is always a good thing, as they can secure higher rates on their savings pots – that is of course if they have spare cash to save in the first place.

“With inflation at 9% and expected to hit 11% later in the year, and UK food prices set to surge 15 per cent this summer as the cost-of-living deepens, saving is becoming a luxury afforded by the few.

“Even those wanting to cash in on rising saving rates may have to wait as banks and building societies can be notoriously slow as passing on the uplift. However, saving rates have been creeping up to the highest levels seen in a decade, with some accounts now offering up to 1.56% for easy access accounts and up to 3% for fixed.

“Finding the highest rate possible is vital for savers if they want to partly offset the high inflation level. Sadly, while higher rates look good on paper, when adjusted for inflation, the real returns on cash are deeply negative. However, a savings pot is still necessary for an emergency fund or short-term needs such as unexpected household costs, holidays or big-ticket purchases, so shop around for the best account.

"Every penny in additional interest is a bonus when high inflation is eating away at the purchasing power of incomes. With many households dipping into emergency pots to meet rising food, fuel and energy bills, you need to make sure your money is working as hard as it can.

“Those with longer-term horizons – more than five years and ideally at least 10 – might want to consider investing it in the markets – taking advantage of lower asset values in these volatile times. While higher returns from the markets is never guaranteed, a long-term approach means your investment portfolio can absorb the highs as well as the lows and deliver better growth over the long term.”

“The worrying effect of higher mortgage payments is people having less disposable income to spend – with the increase coming at a time when household finances are already stretched to the max. For the majority of households, now is a good time to analyse their spending patterns to avoid taking on expensive debt simply to pay your everyday bills.

“A higher base rate can also translate into more expensive loans, credit cards and overdrafts if banks choose to pass on the increased rate. This only adds to the misery for anyone with existing large debts as any increase in interest payments will add to the bill payments, stretching already tight budgets even thinner.

“If you have a fixed-rate personal loan or car loan, the rate won’t change as the terms have already been agreed, but for those shopping around for a new product, the cost of the debt will be higher. Rates on credit cards and overdrafts could also go up, though your lender must alert you before they implement any increases.

“Anyone with niggling credit card debt could consider a 0% balance transfer deal, which can offer up to 24 months’ interest free giving you time 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 credit cards, it might be wise to consolidate them into a loan so that you know exactly how much you need to repay every month and when the debt will come to an end. Personal loan rates are still fairly low, so locking in a good deal now will give you the certainty around what you need to pay is crucial in these financially constrained times. Ideally aim to borrow as little as possible over the shortest time possible to secure the lowest rate possible.”

Jason Hollands, Managing Director of Bestinvest, adds:

“Although today’s 25 basis point rate hike by the Bank of England was widely anticipated, the financial markets had been factoring in 43% chance of 50 basis point move ahead of this. The Bank’s hike looks timid in the context of yesterday’s whopping 75 basis point rise by the US Federal Reserve – the largest increase since 1994. The divergence in relative aggressiveness between the UK and US is unlikely to help shore up the value of Sterling versus the US Dollar which has declined by over 13% over the last year. Sterling weakness of course affects the cost of imports and so has an inflationary effect.  
 
“You would not want to be a central banker at the moment. In truth there are no easy options facing the Bank of England with the need to tackle rampant inflation while trying to avoid tipping the economy into recession. The levers they have at their disposal are not without their limits: increased domestic borrowing costs won’t solve the problem of high energy and food prices, or supply chain disruptions caused by Chinese lockdowns, key components of the inflationary surge. 
 
“For investors, the central scenario of recent months remains unchanged. High inflation is going to linger for some time yet and borrowing costs are only going in one direction: up.  
 
“In this environment, and with the current weakness in Sterling, UK large cap stocks should continue to be relatively well positioned given around three quarters of the FTSE 100’s earnings are made outside of the UK.

“The profile of the UK market also has low exposure to under-pressure sectors like technology and communication services which have been at the sharp end of the slide, but an abundance of energy, materials, consumer staples and healthcare stocks. When the inflation is high and global growth is slowing, investors should hold businesses with strong pricing power that provide goods and services that people will continue to need irrespective of the economic cycle.”

Bestinvest is an award-winning, digital investment platform for people who choose to make their own investment decisions but with the support of tools, insights and qualified professionals. It offers access to thousands of funds, investment trusts, ETFs and shares through a range of account types, including an Individual Savings Account, a Junior ISA for children, a Self-Invested Personal Pension and General Investment Account.

Alongside providing investors access an extensive choice of investments, Bestinvest also offers a wide range of ready-made portfolios for people seeking a managed approach that suit their risk profile, saving them the need to select and monitor their funds themselves. These include a highly competitively priced ‘Smart’ range that invests through low costs passive funds, as well as an ‘Expert’ range that invests with ‘best-of-breed' managers. Investors in ready-made portfolios benefit from a low-cost account fee of no more than 0.20% pa.

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