What do rising interest rates mean for the UK economy?

The Bank of England last week announced that it was raising interest rates for the sixth time in a row to 1.75%, putting them at their highest rate since 2008.

Whilst this move by the Bank of England is being made in the hopes of curbing the rate at which prices are increasing across the UK economy, it has warned that inflation rates could soar as high as 11% later this year. But why is inflation so high, and what do rising interest rates mean for the UK economy?

What is the current rate of UK inflation?

At the time of writing, UK inflation stands at 9.4% – the highest it has been in over 40 years.

The Bank of England has raised the bank rate of interest in response to this. This is the reward people receive for saving money or the cost they incur for borrowing money, which impacts multiple factors across the economy.

Why is UK inflation so high?

A number of factors are impacting the rate of UK inflation, not least the long-lasting impact of the Coronavirus pandemic and the war in Ukraine. Whilst prices behave differently across various markets, the following are some key contributors to the UK’s cost of living crisis and high inflation rates:

• Crude oil: Alongside a multitude of other factors, the war in Ukraine is driving crude oil prices up. This has led to record petrol and diesel prices, alongside a rise in energy bills.

• Food: Food production costs are rising, with produce less easily available due to the COVID pandemic, Brexit and the war in Ukraine.

• Used cars: The cost of used cars has risen since the Coronavirus pandemic due to a parts shortage across the industry causing the production of new cars to slow.

• Raw materials: The high demand for raw materials isn’t being met as output has remained low since the COVID-19 lockdowns and economic dive. This has driven the price of household goods, furniture, accommodation and catering up.

• Mortgages: As the Bank of England raises interest rates in an attempt to curb inflation, mortgage payments have become unaffordable for many homeowners and those looking to get onto the property ladder.

Why is the Bank of England raising interest rates?

In times of economic inflation, the Bank of England raises inflation rates to encourage consumers to save more and borrow and spend less. This limits demand on firms and by association the demand for raw materials and crude oil.

With the rate of inflation increasing rapidly, it is likely that the Bank of England will be forced to raise interest rates even further throughout 2022.

What do rising interest rates mean for the UK economy?

As inflation soars and interest rates rise, UK citizens are facing a cost of living crisis. But what does this mean for the UK economy?

Reduced spending

Whilst high rates of inflation are likely to curb spending across all sectors, increased interest rates are also likely to encourage saving. Saving accounts are offering higher levels of interest to encourage individuals to put away their money, albeit nowhere near the percentage level of inflation.

Falling stock market returns

With the exception of the financial sector, rising interest rates and inflation lead to falling stock market returns as spending and borrowing become more expensive for both individuals and businesses. Investors may decide to opt for short-term bonds to mitigate the likelihood of risky investments.

Housing market crash

Rising interest rates make mortgages unaffordable to many new buyers looking to get on the property ladder, whilst those hoping to remortgage may find deals expensive. Banks may relax the requirements for new mortgage lenders, however, this typically means individuals are required to spend a higher proportion of their monthly income on housing. The result is less demand across the housing sector, and a potential crash of the market as buyers are outpriced.

Stagnation of wage growth & the potential for unemployment

Higher interest rates are predicted to curb wage growth across the economy, with fewer workers receiving pay rises or bonuses throughout this period. Worryingly, the lack of demand across the trade and industrial sectors may lead to increased unemployment, with more workers let go in an attempt to increase business savings.

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