The Bank of England has raised interest rates for the first time since August 2023, citing concerns that the Iran War could lead to a prolonged period of inflation. The Bank Rate has now increased by a quarter of a percentage point to 4%, after remaining at 3.75% for almost a year following a series of reductions from a high of 5.25% three years ago.
The change will immediately affect the 510,000 mortgage-holders in the UK who use a tracker to set their interest rate, while those on a variable mortgage will likely also see an impact. When the bank rate increases, the interest on those loans rises with it, meaning homeowners and businesses will be paying more. Savers, on the other hand, might see a boost to the interest rates offered by banks on their savings.
Why interest rates change
The Bank of England typically adjusts interest rates in response to rising or falling inflation, which measures the rate at which prices are increasing across the economy. When the Bank Rate rises, mortgage rates rise, leaving people with less money to spend on other things. In theory, this fall in demand leads businesses to offer more competitive prices, which in turn reduces inflation.
It is worth noting that falling inflation does not mean falling prices; it simply means prices are not rising as quickly, which can be hard to notice in a weekly shop. The Bank says a rate rise can take as long as two years to filter through to lower inflation.
Why rates are rising now
The last increase came in response to Putin's invasion of Ukraine and the resulting surge in energy prices. This time, the rise is in response to the US and Israel's war on Iran and the associated increase in energy prices. The Bank of England says that raising rates "can't stop the impact of these kinds of things", but it "can slow down new causes of inflation that follow on from these shocks".
Impact on mortgages
Interest rate increases are most keenly felt by people with tracker and variable mortgages. Tracker mortgages follow the Bank Rate directly, so monthly payments will increase immediately. For variable deals, mortgage-holders will need to wait to see how their lender reacts to the rise. According to banking trade body UK Finance, those with a tracker loan can expect their monthly payments to increase by around £31, while those on a variable deal can expect an increase of around £14.
The vast majority of mortgages in the UK, 87%, are fixed, meaning there will be no immediate change to rates. However, future deals will be affected by the latest change, and UK Finance analysis suggests around 2.3 million fixed rate deals are due to expire in 2027. Advice on finding the best interest rates is available on sites such as Money Saving Expert and price comparison providers.
