What's going on?
On Thursday, the Bank of England (BoE) signaled that it may increase its target interest rate (which helps determine the interest rates at which people borrow money) in November – this took investors by surprise!
What does this mean?
In the immediate aftermath of last summer’s Brexit vote, the BoE decreased its target interest rate in an effort to support the economy. Despite its efforts, economic growth in Britain has slowed since then. At the same time, inflation has increased sharply, well beyond the 2% level that the BoE targets. Increasing interest rates would create a headwind for inflation, partly by reducing people’s ability to borrow, and thus spend, money (meaning less upward pressure on prices). On Thursday, the BoE gave its clearest hint yet that it will soon increase interest rates to help tackle inflation, despite the possible negative effect on economic growth.
Why should I care?
For markets: The pound is now at its highest level (versus the US dollar) in over a year!
All else equal, higher rates attract investors to a currency. As such, Thursday’s strong hint from the BoE helped push up the pound versus other currencies. It’s worth noting, however, that even if the BoE does increase interest rates in November, it still appears unlikely to embark on a series of interest rate hikes in the following months – meaning gains for the pound could be limited.
For you personally: Higher interest rates could make it tougher for borrowers.
The first interest rate rise would be an adjustment for borrowers, and if wage growth remains sluggish, they could be left worse off by having to spend higher proportions of their incomes on interest payments. This could lead to knock-on effects, like moderating the increase in house prices (since most people need to borrow money to buy a house). It’s important to note, however, that interest rates remain extremely low by historical standards – and just one increase wouldn’t make a whole lot of difference to your wallet.