While global economies are recovering, as many countries bounce back from the pandemic, there are still significant challenges presenting themselves.
There have been notable periods in history where interest rates have been much higher, but with rates remaining so low for so long, we are now seeing the impact and I think this will continue for an extended time.
On 4 August 2022, the Bank of England (BoE) raised interest rates to 1.75 per cent, which was expected. It was the sixth consecutive interest rate increase and the biggest single one for 27 years, as the UK’s central bank grapples to bring inflation back below its target of two per cent.
With other central banks increasing rates, this trend is set to stay for the foreseeable future. The challenge for many is, not only are borrowing costs increasing, but household budgets are coming under significant pressure as the cost of living continues to rise sharply.
Some commentators are predicting that the UK is facing a tougher ride because households are more exposed to energy price increases and have less government protection than in other countries.
What next for interest rates?
The notion that interest rates will creep up is not new.
There was a lot of speculation in 2015 that they would increase, but inflation dipped, so rates stayed the same. The BoE was so concerned around the EU referendum in 2016, that it dropped interest rates. Pre-Covid, the BoE started to raise interest rates to 0.75 per cent in 2018, but then cut rates to 0.1 per cent.
As a population, we enjoyed borrowing cheaply in the years that followed 2007 to help stimulate the economy and reduce borrowing costs. These times are over for a little while as the Bank of England forecasts it could raise interest rates to three per cent in Q3 2023.
What else could impact the level of interest rates?
- Covid-19 disruptions
As borders reopened and demand for goods and services resumed, supply chains have been significantly squeezed by shortages throughout the process. The knock-on effect is delays and price increases that are ultimately fuelling inflation rises.
- Inflation
Inflation is significantly above the BoE’s official target and still climbing. It’s now at 9.4 per cent, which is the highest level for 40 years and predicted to rise further to 13 per cent by the end of the year, and may soar further because of greater energy costs.
- Change in the Bank of England’s approach
The Bank of England monetary policy committee’s support for low interest rates has disappeared, even though it is unusual to increase interest rates when there is a risk of recession.
- Economic challenges
The UK economy post-Covid is heading for a recession. During the pandemic, the UK economy shrank by 9.9 per cent, but then rebounded to post-Covid levels in 2021.
However, the war in Ukraine has placed significant stress on energy and food costs, which significantly increased costs leading the BoE to predict (and pretty much confirm) the UK would enter recession by the end of 2022 that would last for over 12 months.
Additionally, unemployment has risen for the first time in a year.
UK economic growth forecasts are being changed and the Bank of England believes that the UK economy will contract by 1.25 per cent in 2023 and 0.25 per cent in 2024.
Mortgage interest rates are already shooting up. Whilst numerous borrowers are on fixed rate mortgages now, as these products mature, the rates available will be significantly different than they are used to. With higher borrowing costs, coupled with the spiralling cost of living individuals are already experiencing, this is just extra pressure on household incomes.
All forecasts indicate that the Bank of England will continue to increase interest rates over the next 12 months as the UK wrestles with increasing energy costs, post-Covid challenges and global events that impact us all.
We’re likely to be in for a bumpy ride, strap yourselves in.
