Interest rates: What are they and how high could they go?

·4 min read
Woman using ATM
Woman using ATM

Interest rates have been raised from 1% to 1.25% - their highest level for 13 years.

The Bank of England hopes to slow the rate at which prices are increasing. It has warned that inflation could pass 11% later this year.

Why are prices and interest rates rising?

Prices are going up quickly worldwide, as Covid restrictions ease and consumers spend more.

Many firms have problems getting enough goods to sell. And with more buyers chasing too few goods, prices have risen.

There has also been a very sharp rise in oil and gas costs - a problem made worse by Russia's invasion of Ukraine.

One way to try to control rising prices - or inflation - is to raise interest rates.

This increases the cost of borrowing and encourages people to borrow and spend less. It also encourages people to save more.

However, it is a tough balancing act as the Bank does not want to slow the economy too much.

Since the global financial crisis of 2008, UK interest rates have been at historically low levels. Last year, they were as low as 0.1%.

How high could interest rates go?

Many analysts had predicted UK interest rates would rise this month, but further increases are also expected later in the year.

Analysts at Capital Economics think the Bank will ultimately have to lift rates to 3% to quash inflation, but other economists think they won't have to go so high. Pantheon Macroeconomics reckon interest rates will peak at 1.75%.

Last year, the Office for Budgetary Responsibility (OBR) - the government's independent economic adviser - looked at what might happen if the UK were to experience higher and longer lasting inflation.

This can happen when people think price rises will continue - businesses raise prices to keep making a profit and workers demand wage increases to keep up.

If this happens UK interest rates could hit 3.5%, the OBR said.

Interest rate graphic
Interest rate graphic

How do interest rates affect me?

Mortgages

Just under a third of households have a mortgage, according to the English Housing Survey, which is geographically limited but one of the most comprehensive guides available.

Of those, three-quarters have a fixed mortgage, so will not be immediately affected. The rest - about two million people - will see their monthly repayments rise.

Those on a typical tracker mortgage will have to pay about £25 more a month. Those on standard variable rate mortgages will see a £16 increase.

This comes on top of increases following other recent rate rises.

Compared with pre-December 2021, tracker mortgage customers could be paying about £115 more a month, and variable mortgage holders about £73 more.

Credit cards and loans

Even if you don't have a mortgage, changes in interest rates could still affect you.

Bank of England interest rates also influence the interest charged on things like credit cards, bank loans and car loans.

Even ahead of this latest rise, the average annual interest rate was 20.07% on bank overdrafts and 18.08% on credit cards in April. Lenders could decide to increase these fees now that interest rates have risen.

Savings

The Bank's decisions also affect the interest rates people earn on their savings.

Individual banks usually pass on any interest rate rises - giving savers a higher return on their money.

However, for people putting money away, interest rates are not keeping up with rising prices.

How does the Bank of England set interest rates?

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

They meet eight times a year - roughly once every six weeks - to look at how the economy is performing.

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

Are other countries raising their interest rates?

The UK is affected by prices rising across the globe. So there is a limit as to how effective UK interest rate rises will be.

However, other countries are taking a similar approach, and have also been raising interest rates

The US central bank has just announced its biggest interest rate rise in nearly 30 years, with the Federal Reserve increasing rates by three quarters of a percentage point to a range of 1.5% to 1.75%.

Brazil, Canada, India, Australia and Switzerland have also raised rates, while the European Central Bank has outlined plans to do so later this summer.

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Do you have a tracker mortgage and will now see your repayments rise? Are you worried that rising rates might affect your finances? Email haveyoursay@bbc.co.uk.

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