Over the previous 10 years, interest rates in the UK have remained fairly constant at record lows and consistently below 0.5%.

However, as the UK economy now records strong growth in the wake of the Covid-19 pandemic, the Bank of England has been compelled to increase the Bank Rate in order to curb inflationary pressures on consumers.

UK GDP has consistently outgrown forecasts since the end of Covid-19 restrictions as business and consumer confidence have recovered strongly. 12-month CPI inflation rose from 5.4% in December to 5.5% in January, which has triggered the interest rate rise.

Rising costs are forcing prices and interest rates upwards

The Bank of England, in its report explaining the interest rate rise, has mentioned increasing costs faced by businesses and consumers alike. Service price inflation has picked up, with nominal earnings growth expected to strengthen over the next 12 months. Energy prices remain a headline with Ofgem raising the utility price caps from April.

The Bank of England notes that utility prices could further rise when they are reset in October 2022, which could force inflation back towards a second peak. Substantial increases in the prices of energy and raw materials remain a key factor in the Bank’s decision.

Exchange rate pressures on the Bank of England

The Bank of England has also named the exchange rate as a key factor in the decision to raise the Bank Rate, the sterling effective exchange rate had fallen by 1.7% since the previous MPC meeting against the US dollar. As the Federal Reserve is expected to continue to increase the US interest rate, the Bank of England may be concerned with the value of the British Pound against the Dollar.

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Raising the interest rate, increases the incentive for saving and significantly increases the reward for purchasing domestic bonds for international investors. This increases the demand for the British Pound Sterling thus increasing its value.

The Russia-Ukraine invasion has shocked the economy

The Russia-led invasion of Ukraine in late February has presented a significant shock to the UK economy. Commodity prices have risen heftily and continue to display worrying market volatility. Russia supplies around 40% of the gas used in the Euro area and was the world’s second largest global crude oil producer.

Both Russia and Ukraine were also key producers in other markets, including food and metals, both of which have seen respective rises of around 15 and 20% in the past month. Significantly, Russia and Ukraine also accounted for almost 30% of the world’s wheat exports and Russia supplied 16% of the world’s fertilizer. The impact on global markets is two-fold: initially through the economic shock and financial consequences of the invasion and secondly, the harming and inhibiting of supply chains that both countries were significant producers in.