Bank of England raises UK interest rates to 13-year high of 1.25%

The Bank of England (BoE) has raised UK interest rates to a 13-year high of 1.25% as it now predicts inflation it will hit 11% this autumn, when energy bills rise.

It is the first time since January 2009 that the rate has been higher than 1%. At its May meeting, the BoE increased the base rate to 1%.

Some had even speculated the rise could reach 1.5% – a so-called 50 basis points rise.

Six out of nine Monetary Policy Committee members voted for a 0.25 basis point hike leading to a fifth consecutive raise.

Three members of the Monetary Policy Committee – Jonathan Haskel, Catherine Mann and Michael Saunders — voted to raise interest rates to 1.5%, which would have been the biggest rise since 1995.

"Faster policy tightening now would help to bring inflation back to the target sustainably in the medium term, and reduce the risks of a more extended and costly tightening cycle later," they said.

But six members — Andrew Bailey, Ben Broadbent, Jon Cunliffe, Huw Pill, Dave Ramsden and Silvana Tenreyro – voted in favour of a smaller, quarter-point rise to 1.25%.

The Bank’s Monetary Policy Committee has voted for a rise in each of the last four meetings, in December, February, March and May.

The Bank of England also raised its forecast for the peak of inflation this year to "slightly above" 11%. This reflects the planned increase in the energy price cap in October. The BoE also now expects the economy to contract in the current quarter.

GDP is now expected to drop by 0.3% across the quarter, weaker than anticipated just over a month ago.

The BoE signalled that it would “act forcefully” if needed to prevent high inflation becoming more persistent.

"The MPC will take the actions necessary to return inflation to the 2% target sustainably in the medium term, in line with its remit. The scale, pace and timing of any further increases in Bank Rate will reflect the Committee’s assessment of the economic outlook and inflationary pressures," ti said.

"The Committee will be particularly alert to indications of more persistent inflationary pressures, and will if necessary act forcefully in response."

Read more: Is the UK heading into a recession?

UK inflation soared to a 40-year high of 9% annually in April as food and energy prices spiralled, and the country faces a major cost of living crisis. The BoE expects inflation to rise above 10% later this year.

Read more: UK inflation heading for 14% for poorest households

Karen Noye, mortgage expert at Quilter, said homeowners would feel even more squeezed after the rate hike.

"After today’s rise to 1.25%, someone with a mortgage worth ￡250,000 over 25 years would pay a monthly payment of roughly ￡970. If interest rates climb to 2% monthly payments would soar to ￡1,059, a huge ￡89 difference. With energy and food prices climbing too, this could spell disastrous news for families up and down the country.

"Further rate hikes are certainly not out of the question, and this could start to impact house prices. The housing market is already showing signs of a slowdown and how well it can weather further rate rises, alongside raging inflation, is yet to be seen but the prognosis is not good."

Lenders have raised mortgage rates by as much as 0.5 percentage points shortly before the BoE's announcement, including HSBC and NatWest.

The OECD has forecast the UK will be the weakest G7 economy in 2023 as higher interest rates, tax increases, reduced trade and soaring food and energy costs weigh on households.

Alan Custis, portfolio manager at Lazard Asset Management said: “The MPC continues to balance the inflationary effects on the economy, with the very real chance that they tighten too much and the UK economy lurches into a full blown recession. Andrew Bailey, governor of the Bank of England, has been slow in tackling inflation, for which he has come in for some criticism by MPs, and this move today balances all of the factors that are currently weighing on the economy.”

Interest rate, as defined by the Bank, is what you pay for borrowing money, and what banks pay you for saving money with them. Its purpose is to help regulate inflation.

Renters are likely to come under pressure, as buy-to-let landlords pass on higher borrowing costs to their tenants.

Record high inflation is forcing central bankers to become more hawkish, with the US Federal Reserve hiking its key rate by 75 basis points last Wednesday night.

Laith Khalaf, head of investment analysis, AJ Bell, said: “The Bank of England is playing a game of slowly, slowly catchy inflation, rather than the shock and awe tactics being employed across the Atlantic. Despite the UK starting to tighten monetary policy first, interest rates are now higher in the US. Markets will no doubt seize on this as a sign the Bank of England has bottled it, but an incremental strategy allows the rate setting committee to observe more data as it comes in, and fine tune its approach as circumstances dictate."

Watch: How does inflation affect interest rates?