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Interest rates hiked again as inflation bites

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As the UK lurches ever closer to recession, and soaring inflation continues to squeeze households and businesses, the Bank of England has raised interest rates by 0.25% for the fifth consecutive time.

16th Jun 2022
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The highest inflation in 40 years has led the Bank of England (BoE) to hike interest rates to 1.25%, with inflation slated to hit 11% later this year and the threat of recession starting to become a looming reality.

In a split decision, the Monetary Policy Committee (MPC) voted by a majority of 6-3 to increase Bank Rate by 0.25 percentage points, to 1.25%. Those in the minority preferred to increase Bank Rate by 0.5 percentage points, to 1.5%.

While today’s increase continues this trend, the MPC decision is less bullish than the 0.5% rise that many had speculated before the announcement. 

The BoE’s hike in interest rates trails behind the Federal Reserve’s more aggressive 0.75% increase in the US interest rates yesterday, as they also attempt to suppress their own inflation pressures. This is the biggest hike from the Federal Reserve since 1994.

The last time the MPC increased interest rates in May was the highest level in 13 years.  

40-year high

The BoE’s original inflation target of 2% by the end of the year has slipped away. Weeks after the last interest rate announcement in May, inflation hit the 40-year high of 9%. The BoE said in May that inflation was going to creep higher to 10% by the end of the year, but they are now projecting it to rise to 11% in October, reflecting the higher projected household energy prices.  

“The MPC will take the actions necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit. The scale, pace and timing of any further increases in Bank Rate will reflect the committee’s assessment of the economic outlook and inflationary pressures.”

The BoE said the committee is on guard for any “persistent inflationary pressures” and if necessary “will act forcefully in response”. 

Inflation was surging before Russia invaded Ukraine, but since then global inflationary pressures have intensified and have led to a deterioration in UK growth. These pressures have not abated since the last MPC report, with supply chain disruption and the aftershocks of Covid still hampering the UK economy.

“Inflation’s overshoot of the 2% target mainly reflects previous large increases in global energy and other tradable goods prices. The former has been greatly exacerbated by the war in Ukraine,” said the BoE. These same challenges remain but the excess inflation can be attributed to other global events. 

“There has also been a role for interactions with domestic factors, including the tight labour market and the pricing strategies of firms. Consumer services price inflation, which is more influenced by domestic costs than goods price inflation, has strengthened in recent months. In addition, core consumer goods price inflation is higher in the United Kingdom than in the euro area and in the United States.”

The MPC will meet and announce any changes to the base rate on 4 August. 

Accountants back interest rate hike

Since the BoE has increased interest rates after each MPC meeting, the accounting profession has debated whether this is the right approach in managing the economic pressures the UK is facing.  

When the base rate increased to 1% in May, the AccountingWEB community mostly backed the decision. Petestar1969 said, “About time too, but I agree with Rishi more needs to be done. No sensible economy should have a base rate below 2%.”

Ian McTernan wasn’t concerned that the rate was on the increase. “People have become used to very cheap money. It’s high time rates moved back to more sustainable levels.” He added that those criticising the increase “fail to consider the adverse impact on the exchange rate of not moving rates”.

Justin Bryant echoed this: “Interest rates have been far too low for far too long and that, as well as money printing and extreme government borrowing, is one of the main causes of high inflation and inflated asset prices. That in turn has caused wealth inequality to increase big time over the past 10 years.”

While accountants seem in favour of an increase, do you think the Bank of England should have been more assertive and followed the Federal Reserve’s lead and nudged the interest rate hike more than 0.25%?

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Replies (15)

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Glenn Martin
By Glenn Martin
16th Jun 2022 12:08

Need to forget about parties and get on with governing the country and deal with this.

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Replying to Glennzy:
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By Hometing
16th Jun 2022 12:13

We both know they'll end up mismanaging that too

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By petestar1969
16th Jun 2022 12:24

Nice to be quoted, thank you. Guess what? This is another step in the right direction, but smaller than I'd like.

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By ROBBIEWHITE
16th Jun 2022 13:01

Interest rate needs to be raised further to 4-5%, also I think 11% inflation by the year-end seems optimistic, could we be seeing a return to inflation adjusted accounts?

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By Justin Bryant
16th Jun 2022 13:10

And to think that some of these so-called economic experts at BoE were promoting the idea of -ve interest rates around a year ago! The old economist/weather forecaster analogy applies accurately here as ever.

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Danny Kent
By Viciuno
16th Jun 2022 14:13

I completely disagree with the apparent consensus.

Increasing interest rates will just have the exact opposite effect - it will just push prices up on the whole for the majority of the population.

Price rises are not being driven by excess spending by the population, but by factors outwith the control of the BOE. The largest inflationary pressure at the moment is price of gas and oil - and no amount of interest rate hikes will solve that problem (neither will a fuel duty cut, but that is another question altogether).

Honestly, I think they are increasing rates now as it is already going pear shaped so may as will "lose" the effect of the increase in whatever other disaster Boris brings upon us (like the impending EU trade war). They can decrease it later on when we need to - the fact they were considering "-'ve" rates just illustrates that they had nowhere left to go.

Happy to re-evaluate my position though if anyone can explain how increased interest rates will result in lower inflation in the current climate (I'm aware of how it should work, just don't see current inflation being pushed up by the general populous' spending power)

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Replying to Viciuno:
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By Justin Bryant
16th Jun 2022 14:47

Inflation is mainly caused by too much money chasing too few goods. By raising interest rates, the money supply decreases (as borrowing becomes less attractive - would/could you take on a new £2m mortgage at 10% p.a. interest rates?) all else being equal. It's that simple.

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Replying to Viciuno:
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By petestar1969
16th Jun 2022 15:37

Most of the current inflation is due to cheap debt and QE since 2009.

Folks are discouraged from saving (keeping their money in the bank), as interest rates are too low, so invest in property by leveraging their money with cheap debt and pushing up house prices.

Higher rates would stop this happening.

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Replying to petestar1969:
By Nick Graves
16th Jun 2022 16:44

It's partly due to the helicopter money during the plandemic and of course the Magic Money Tree Theory since '08, it's true.

OTOH, this is supply-side inflation caused by said plandemic, sanctions (ie threatening to shoot yourself if the other party doesn't comply) mad environmental policies, etc - raising interest rates is in that case futile.

Although a rise from 1-2% is massive in relative terms (as Richard kindly explains below), it's nothing when REAL rates of inflation are what they are. But if they tried to go full monetarist and put the real rate positive (instead of negative), they'd get demand destruction alright, but the rising bond yields on all that debt would bankrupt the country.

Enjoy the ride to the bottom, guys!

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Replying to Nick Graves:
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By Justin Bryant
16th Jun 2022 17:12

The Magic Money Tree Theory is not new and has been known by anyone with half a brain cell since the early 1970s (which excludes most economists of course).

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Replying to Viciuno:
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By Mattax
17th Jun 2022 09:47

Agree with this completely. I don't see how an interest rate hike at this time helps anything when all the factors for inflation are external. We have had low interest rates for 10 years with low inflation so to blame it on that now doesn't make sense.

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Richard Hattersley
By Richard Hattersley
16th Jun 2022 16:34

Some interesting commentary from Mazars has just dropped into our inbox. The accountancy firm argues that the increased cost of borrowing is likely to force more companies to shut their doors.

"Analysis of Bank of England data by Mazars shows UK businesses are currently paying £11.2 billion annually in interest payments on floating rate debt that are likely to be immediately impacted by an interest rate rise. Businesses that have to refinance their fixed-rate debt will be hit by the rate rise later.

"With rates rising by just 0.25%, annual interest payments on business lending will increase to £12.1bn almost overnight.

"Further increases in the base rate would have a yet more dramatic impact. If interest rates were to rise to 2%, interest payments for businesses would rise by a further £3.7bn to £14.9bn."

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Replying to Richard Hattersley:
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By Justin Bryant
16th Jun 2022 17:20

But that's peanuts. UK GDP is c$3tn p.a. (This ain't Nicaragua you know!)

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Replying to Justin Bryant:
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By Hugo Fair
16th Jun 2022 18:34

And (draws deep breath and erects missile deflector shield), just because a company can't afford to service its debt ... why should we have to help them out?
They knew what they were doing when they borrowed (and if they didn't then they shouldn't be in business), so why is it someone else's (aka our) problem now?

The inference from the Mazars report appears to be 'you can't go back to real (inflation adjusted) positive interest rates, or anything approaching that, because it would cripple some companies' ... which only reminds me of the needy cry from a dumped lover of "if you leave me I'll kill myself". [I did warn you that I'm in direct speak mode].

Of course you feel for the person (or indeed company) suffering, but that doesn't mean you should stop doing what is the right thing.
And yes, companies going to the wall will hurt more than just the shareholders, but the current approach is far more likely to end up sinking the whole fleet (not just damaging a few ships) ... to use a metaphor.

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Replying to Hugo Fair:
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By Justin Bryant
17th Jun 2022 08:02

Totally agree. If you take out a variable interest rate loan that you end up not being able to afford (for whatever reason) why is that my (or anyone else's) problem or concern? Why should anyone else underwrite their borrowing risk? These are after all all grown up people.

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