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It’s been exactly a year since the Bank of England started raising interest rates from a record low of 0.1%. Threadneedle Street has raised borrowing costs at each of its nine meetings since December 2021 and is now at 3.5% after a recent 0.5 point jump.
By historical standards that seems like nothing to get worked up about. In the period between 1997 – when the bank was granted its independence – and the onset of the financial crisis a decade later, interest rates never fell below 5%. In the 1970s, 80s and early 90s, official lending rates were often in the double digits.
There is no remote possibility that rates will return to 10% or more in the current tightening cycle. Financial markets believe they will peak at 4.75% next year after further action by the Bank to reduce inflation.
However, the speed at which rates have risen and the growing perception among borrowers that there will be no return to crisis levels reached during the Covid-19 pandemic will have an impact on an already weak economy. Interest rates have been at record lows for more than a decade since the 2007-08 financial crisis, and an entire generation has grown up believing that ultra-cheap borrowing is the norm. What’s more, many people have bought homes with high loan-to-income ratios that mortgage rates will remain permanently low.
They have now seen interest rates rise more in the past 12 months than in any year since 1989 and are now facing a serious reality check. While fixed-rate home loans will protect them for a while, they will eventually have to remortgage at a significantly higher rate.
As the minutes of the recent meeting of the Monetary Policy Committee (MPC) show, the boom in the housing market is over. Buyer demand is weakening and both Nationwide and Halifax have reported sharp monthly declines in property prices.
The good news for over-extended borrowers was that two of the MPC’s nine members – Swati Dhingra and Silvana Tenrio – voted to keep interest rates at 3%. The bad news is that most of the committee thinks that further rate hikes “may be necessary” for a sustainable return to its 2% inflation target. One member, Catherine Mann, supports an increase of 0.75 points.
So, the likelihood is that rates will rise again at the Bank’s next meeting in February and won’t start coming down again until the MPC is convinced that pay pressures are easing.
The message for borrowers is clear. Unless there is a fresh, unexpected shock, official rates are unlikely to return to 0.1% and they will have to adjust to a new, tougher, environment.
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