Interest rates: What are they and how do they affect inflation?

Interest rates rose to their highest level in 13 years on May 6 as the Bank of England (BoE) struggled to temper surging inflation, which however soared to 9 percent and could go higher yet.

The institution’s Monetary Policy Committee decided to raise the base interest rate from 0.75 percent to 1 percent, the fourth consecutive time that the panel has voted in favor of an interest rate increase.

Governor Andrew Bailey had warned before the announcement that the BoE must walk a “very fine line” between cooling inflation and triggering a recession.

Consumer confidence fell last month and retail sales were lower than expected, due to the impact of soaring energy bills, food prices and fuel costs.

Here’s a quick and easy guide to how the latest interest rate change will affect you.

What are interest rates?

An interest rate is a measure that tells you how high the cost of borrowing money is or how high the rewards of saving are.

If you’re borrowing money, usually from a bank, the interest rate on that money is the amount you’ll be charged for borrowing it.

It is an additional charge to the total amount of the loan and will be shown as a percentage of the total.

Cost of living: how to get help

The cost of living crisis has touched every corner of the UK, pushing families over the edge with rising food and fuel prices.

  • the independent has asked the experts to explain little ways you can stretch your money, including managing debt and getting items for free.
  • If you need to access a food bank, search for your local council website using and then use the local authority site to locate your nearest centre. Trussell Trust, which runs many food banks, has a similar tool.
  • Citizens Advice provides free help to people in need. The organization can help you find grants or benefits, or advise you on rent, debt, and budgeting.
  • If you are experiencing feelings of distress and isolation, or are struggling to cope, The Samaritans offer support; you can speak to someone free of charge by phone, in confidence, on 116 123 (UK and ROI), email [email protected] or visit the Samaritans website to find details of your nearest branch .

Higher percentages mean paying more money to the lender for borrowing the money.

If you’re saving money in a bank account, the interest rate on that money is the amount you’ll accumulate in addition to your savings. Banks will pay you a percentage of your total savings, usually at the end of the year.

How do interest rates affect inflation?

Low interest rates are used to discourage people from accumulating their money in savings. High interest rates encourage saving because people get a better return on the money they are saving.

This in turn has an effect on the price of goods.

When interest rates are low, people can spend more and this can cause retailers to raise the price of goods.

When interest rates are high, demand can drop as people put more money into their savings. This, in theory, should drive down the prices of goods and services.

However, the increase in prices is not a direct result of changes in interest rates. Other things, including the money supply and underlying costs, affect prices and cause inflation.

Interest rates can only help control inflation.

How do interest rates affect mortgage rates?

Changes in the BoE base rate, which is the interest rate at which banks borrow from the Bank, have a ripple effect on the interest rates that high street banks then charge their mortgage borrowers.

How does this affect me?

Changes in interest rates will affect anyone who has savings and anyone who is borrowing money from banks, for example in a mortgage.

It will also have a broader effect on the economy. By raising the base interest rate, the BoE hopes to temper runaway inflation and help with the cost-of-living crisis.

Despite this, inflation is forecast to continue to rise in the near future, with a slope that will eventually exceed ten percent.

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