The first interest rate rise in over a decade will be a novelty for households and businesses but it is likely to take some time before many borrowers notice the difference.
Changes in borrowing patterns mean that many consumers and companies will be less immediately exposed to higher rates than they were in the past.
By increasing its benchmark rate on Thursday by a quarter of a percentage point to 0.5 per cent, the Bank of England’s objective is to suppress inflation, which is running above its 2 per cent target.
The central bank’s Monetary Policy Committee signalled that at least two further quarter of a percentage point rate rises would be needed over the next two years.
Raising rates affects the economy, and therefore inflation, through many different channels: for example, it can cause sterling to appreciate. But the most direct impact on households and businesses comes through the effect on loans and savings.
Frances O’Grady, TUC general secretary, responded to the MPC announcement by warning: “This is the last thing hard-pressed families need.”
But the BoE analysis in its new inflation report suggests that there are several reasons to think that the rate rise will be felt less quickly than was the case in the past. “This is a modest adjustment in interest rates,” said Mark Carney, BoE governor.
One important way that households will feel the effects of the rate rise is through the interest they must pay on their mortgages.
The BoE estimates that the 0.25 percentage point increase in rates will raise the servicing cost of the average mortgage by £15 a month once it is fully passed on by lenders.
But fewer households will be immediately affected this time around than was the case in previous rate hiking cycles.
Fewer people now own their own home. Those who do are more likely to own outright — the proportion of UK households that have a mortgage has declined from 35 per cent in 2000 to 24 per cent now.
Three-fifths of mortgages are now fixed rate, rather than variable. That means it will take some time for the rate rise to affect many households’ borrowing costs.
Furthermore, the BoE estimates that people coming off a five-year fixed-rate mortgage now could still negotiate a replacement at 2 percentage points below their current deal, in spite of the MPC announcement.
“For most homeowners the effect of today’s rise will be modest or negligible,” said Matt Whittaker, an economist at the Resolution Foundation, a think-tank.
But some people will be more heavily affected: Mr Whittaker’s analysis shows that those most likely to have variable-rate mortgages are in their late 40s and early 50s and generally in higher-income groups.
The interest rates on families’ non-mortgage borrowing, including credit cards and other unsecured loans, are less closely tied to the MPC’s announcement.
Most of these loans are fixed rate. Lenders charge a large premium over the BoE rate, which could be compressed as monetary policy tightens.
While most borrowers will expect eventually to face an increase in interest costs as a result of the MPC’s announcement, there is one group that could experience the opposite.
If the bank’s monetary tightening has the desired effect of suppressing inflation, interest rates applied to student loans will fall, since these are pegged to the retail prices index. Graduates’ monthly repayments, however, are determined exclusively by their earnings level.
A more immediate impact on families’ cash flow will come from changes to the interest rates earned on savings. Most savings accounts pay a variable rate of interest, and Mr Carney said that he expected the rise in the BoE benchmark to be passed on to depositors.
Yael Selfin, an economist at KPMG, said “long-suffering savers will rejoice” at the first increase in interest rates in over a decade.
Companies are likely to experience a more immediate impact on their borrowing costs than households will, as the vast majority of business loans involve a floating interest rate.
But loans have become a less important source of business financing than they once were. Some companies are running more conservative balance sheets, and large groups have increased their use of bond and equity issuance.
Mike Cherry, chairman of the Federation of Small Businesses, warned that small businesses still faced a challenge. “[The] rate rise will mean yet more cost pressures for small firms as they battle spiralling prices and flagging consumer demand,” he said.
The impact of higher borrowing costs on companies’ profits will be lower on average than in the past, however.
The share of profits that are required to meet debt servicing costs has fallen sharply, from above 25 per cent to below 10 per cent, since the financial crisis.
Even if the full 0.25 percentage point rate rise was passed on, this profits share figure would increase by only 0.5 percentage points, according to BoE analysis.
Thursday’s rate rise will increase financial pressure on borrowers. But even if the MPC follows through with two further quarter of a percentage point rate increases, the BoE benchmark would still only be 1 per cent, which is low by historical standards.
“[The rise to 0.5 per cent] will have an impact on borrowers over time . . . [but] it leaves monetary policy in a position where it is still highly supportive,” Mr Carney said. “It is the policy that is providing a boost to the economy relative to headwinds from . . . fiscal policy and the uncertainties associated with Brexit.”
Bank of England governor Mark Carney © Bloomberg