Updated: Mar 22, 2022
The Bank of England hikes interest rates to 0.75% in its third first rate increase in an attempt to get a grip on soaring prices.
It is expected to increase further as energy bills rise next month due to the price shock caused by Russia's invasion of Ukraine filters through to the consumers.
It was only a month ago that the Bank predicted that the inflation would peak at 7.25% in April this year. However, due to Ofgem’s energy price gap hike announcement which was bigger than officials expected, this has prompted the Bank to bump up the projection to 8%.
The Interest rate rises are used by central banks to increase the cost of borrowing so as to suppress demand and, in theory, bring inflation back down to target.
Savers benefit from higher interest rates as they offer higher returns on savings; mortgage borrowers on variable interest rates face higher costs as interest rate rises are typically passed on in full by lenders in the next monthly bill. About 2.2 million people across the UK have variable mortgages.
The latest inflation figures are at almost three times the central bank’s target of 2%. Unemployment levels are close to historic lows at 4.1% and the number of vacancies is almost equal to the number of people jobless for the first time since comparable data was recorded more than twenty years ago.
HOW WOULD HIGHER INTEREST RATES AFFECT THE ECONOMY?
In general, higher interest rates increase the cost of borrowing. As the value of loans decrease, lenders need higher interest rates as the money they are paid back shrinks in value.
That means if interest rates are higher, businesses will be restricted from growth strategies like taking out loans, investing in new equipment, or hiring more workers. Higher interest rates also reduce disposable income as interest on loan repayments, such as mortgages, increases. This would limit consumer spending, which could hit small business revenue.
Of course, the impact is not all negative, otherwise higher interest rates wouldn’t be introduced. An increase also tends to reduce pressures caused by high inflation, and means people are less likely to engage in risky investments and borrowing. This means that the economy is more closely moderated which is good for stabilisation, but bad for growth and employment.
WHAT DOES THIS MEAN FOR SMEs?
Because interest rates are essentially a tax on borrowing, they disproportionately affect small businesses over medium-sized ones, as small businesses in their early stages of growth rely more heavily on funding.
The UK has had record-low interest rates since the 2008 financial crisis, as banks attempted to stimulate the economy back to good health by slashing rates to 0.75%. Following the disruption of the coronavirus pandemic, they were lowered to their current base rate level of 0.1%.
Increasing rates now means that UK small businesses with company credit cards and existing loans will be forced to spend more on interest payments, reducing cash flow by giving you less disposable income and bigger overheads.
WHO WILL BE MOST AFFECTED?
Interest rates make borrowing very expensive. That means navigating higher rates will be particularly difficult for companies which have already struggled due to coronavirus and have accessed financial loans for support. It will also be harder for startups to access finance.
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