Interest rates: What are they and why do they matter?

The Bank of England will today decide to either raise interest rates or keep them at 0.5%.

It comes a day after the US Federal Reserve raised interest rates for the for the first time since 2018.

Many economists expect inflation to reach 7% this year, which would be its highest level since March 1992.

In the UK, interest rates peaked in 1979 at 17% during a period of high inflation and high unemployment. It’s unlikely they’ll rise that high this time.

A few weeks before Russia’s invasion of Ukraine, the Bank had expected inflation to climb above 7% this spring before then easing.

Since then, global energy prices have shot up, with Brent crude oil prices hitting a near 14-year high at one point. It can now cost more than £90 to fill a family car, according to the RAC.

Central banks usually prefer to raise interest rates slowly to avoid market shocks, so few expect the Bank of England interest rate to top 1.25% this year.

Setting interest rates – officially known as Bank Rate – is one of the many ways the Bank tries to control the UK economy.

If interest rates rise, it can make borrowing more expensive – especially for homeowners with mortgages.

As well as mortgages, Bank of England interest rates also influences the interest charged on other forms of credit, such as credit cards, bank loans and car loans.

So even if you don’t have a mortgage, changes in interest rates could still affect you.

Bank of England decisions also affect the interest rates people earn on their savings. Individual banks usually pass on any interest rate rises to their savers – giving them a higher return on their money.

Interest rates are decided by a team of nine economists, the Monetary Policy Committee.

It meets eight times a year – roughly once every six weeks – to look at how the economy is performing.

Its decisions are always published at 12:00 on a Thursday.

If interest rates go up, it is intended to encourage High Street banks to put up the rates they charge borrowers. This has the effect of slowing economic activity – people are less likely to borrow money to spend if they know it will cost more.

Higher interest rates mean people earn more on their savings – which should encourage them to save rather than spend.

Encouraging people to do this should slow the increase in prices of everyday goods. With fewer buyers in the market, sellers will find it hard to put up their prices.

On the other hand, cutting interest rates makes it cheaper to borrow money and people get less return on their savings. The aim here is to encourage people and businesses to spend or invest.

The Bank of England raises or lowers interest rates to help maintain its 2% inflation target.

Inflation is the rate at which prices are rising – if the cost of a £1 jar of jam rises by 5p, then jam inflation is 5%.

If prices – sometimes known as the cost of living – are rising faster than 2% a year, the Bank will consider putting up interest rates.

And in 2020, it cut interest rates to its lowest-ever level of 0.1% as Covid caused the biggest economic slowdown for centuries.

Do you have a tracker mortgage and will now see your repayments rise? Are you worried that rising rates might affect your finances? Email [email protected].

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