The Bank of England (BoE) raised the main interest rate in the UK by half a percentage point. The central bank wants to use this to fight inflation, which is still at a high level despite previous interest rate hikes. As interest rates rise, it becomes more expensive to borrow money and less money is available, which should lower prices.
The fact that interest rates have been raised is no surprise, says correspondent Lia van Bekhoven. On the other hand, the percentage is surprising. “The hope was that it would be less than half a percent.”
The UK central bank was one of the first central banks to raise interest rates in December 2021 and has now raised them thirteen times in a row, all the way to a level of 5.00%. This is the highest rate since 2008. The jump in the interest rate was larger than the quarter-percentage point increase economists had expected.
Basic inflation
Although inflation is falling in the UK, the rate at which it is falling is much slower than in other countries. “Core inflation, which excludes food and energy, continues to rise and is now at 7.1%,” said BNR in-house economist Han de Jong. “There’s a big concern about the persistence of inflation in the UK and that’s why the Bank of England is doing it.” It emerged earlier this week that UK inflation remained unexpectedly high in May at 8.7%. Economists had expected a drop, but the inflation rate remained the same as in April.
The question is why inflation in the UK is difficult to control, which seems to be successful on average in the European Union and the United States. Here too, inflation is declining, mainly due to lower energy costs and a slower rise in food prices.
Brexit
It is clear to Van Bekhoven that Brexit is one reason for this. “If you have to import two-thirds of your fresh fruit and vegetables from the European Union, then it stands to reason that those products become more expensive because there are costs.”
But the situation on the labor market also plays a role here. There are severe shortages of workers. Available personnel demand and therefore receive considerably higher wages. “The UK has wage inflation of 7.5%,” says Van Bekhoven.
Prime Minister Sunak’s bombing of inflation as a top priority has so far had no effect. No surprises for De Jong. “For one thing, this is hard to achieve. Ultimately, it’s a result of how the economy is doing. This is more the task of a central bank.’ According to De Jong, it is important for the economy to become more “balanced”, which will ultimately reduce the pressure on prices.
Mortgages
There are particular concerns about the consequences of rising inflation for millions of Britons on mortgages. “But curiously, a government official said a recession due to high interest rates ‘has to be done.'” But there aren’t many buttons the Bank of England has to flip other than interest rates.
The fact that the consequences for mortgage owners are so great, according to Van Bekhoven, has to do with the short term of the loans. ‘Over the past thirteen years, people have gotten used to taking out mortgages with terms of about two to five years. And all those people have directed their lives to those low mortgage rates.
Time bomb
According to Van Bekhoven, the new increase in interest rates is therefore “a time bomb” for the British economy. ‘It’s a bombshell under the mortgages of almost 1.5 million Britons who have maturing loans. The new loans are two to three times more expensive than the previous loan.’ Difficult times are also ahead for tenants, because homeowners will also pass on the higher prices to the tenants. ‘This is also a big problem.’
Van Bekhoven points out that the situation could also become tense politically, because the pressure on British Prime Minister Sunak will increase further. “Conservative group MPs are inundated with emails and phone calls from voters who can no longer pay their mortgage.” However, former UK finance minister Sunak has no other means than interest rates to combat “this inflationary specter.” But since only the central bank can turn that knob, so does criticism of the Bank of England. “He should have predicted it sooner and he should have raised interest rates sooner.” The opposition is now talking about a new economic crisis in Great Britain.