With news of interest rates increasing yet again, many are wondering just how high they could go and what effect these rises will have on their quality of life. In this piece, we look at some of the facts surrounding interest rate increases, and what we can expect from the next couple of months.
Unfortunately, interest rates are likely to continue to rise as the Bank of England aims to battle the increase in inflation, which has been caused by a number of economical factors, including effects of the Russian war in Ukraine on energy prices, shortages of food due to unpredictable weather, and import issues resulting from Brexit. According to Shroders, the UK should brace for interest rates to peak at 6.5% by the end of 2023, from the current August rate of 5.25%.
The theory surrounding raising interest rates to lower inflation is that by raising them, borrowing becomes more expensive, thereby encouraging people to save more. This then reduces the demand for goods and services, which will prompt businesses to lower their prices. In general, when rates decrease inflation rises, and when rates are high inflation falls.
The Bank of England is therefore hoping the increase in interest rates will affect spending habits by slowing down the purchase of things captured in the Consumer Price Index (CPI) measure of inflation – outside of the everyday essentials such as food, housing, transport and household bills.
Some experts say that a recession is inevitable in the face of the Bank of England’s interest rate increases. As mentioned above, if interest rates peak at 6.5% by the end of the year, it could push the economy into a recession. With the BoE prioritising inflation over growth, it may be that a fall in GDP could follow in 2024. This could be a result of inflation being higher than the BoE initially expected, due to the global factors mentioned above (energy issues, Brexit, post-COVID landscape etc).
The money accrued through increased interest rates goes to commercial banks, insurance companies, and brokerages. It effectively means that borrowing money becomes more expensive, with lenders making more money by profiting from the larger gap between the interest they pay their customers and the profit they make from investing.
There are a couple of alternatives to raising interest rates, but these may actually leave the average UK resident even worse off. Raising taxes to cut spending is one such method, however this would put even more financial pressure on millions of people whose living standards may have already taken a hit. It could also push the economy into a recession regardless.
Another theory suggests that central banks make corporate expansion more expensive by increasing the cost of borrowing for companies, thereby slowing down expansion plans and encouraging them to reduce prices in order to compete.
