The Bank of England has raised interest rates to 0.5 per cent in its first back-to-back rate rise for 17 years in an attempt to get a grip on soaring prices.
The monetary policy committee was divided on whether to raise rates by 0.25 percentage points or by even more, with five members, including the governor Andrew Bailey, voting to increase rates to 0.5 per cent and the other four opting for a bolder raise of 0.5 percentage points to 0.75 per cent.
Andrew Bailey said that rising energy prices, and the impact of coronavirus, had contributed to the recent interest rate increase. 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.
At 5.4 per cent, the latest inflation figures for December are at almost three times the central bank’s target of 2 per cent. Unemployment levels are close to historic lows at 4.1 per cent 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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