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The Bank of England’s Monetary Policy Committee (MPC) meets this week to decide whether to raise the Base Rate – the figure that helps determine the interest rates people pay on mortgages, savings accounts and more.
Currently the Base Rate, which is the interest rate commercial banks get for holding money with the central bank, stands at a historic low of 0.1%. Back in 1981 it was as high as 15.06%, but it has been below 1% since 2009.
Nine MPC members, including senior Bank figures and some government appointees, meet every six weeks or so to decide whether hiking that figure will benefit the economy, with a view to keeping levels of inflation at a target rate of 2%.
MoneyTransfers.com explains how a rate rise could affect the value of the pound and when we’re likely to see this.
How does an interest rate rise affect currencies?
In a nutshell, an interest rate rise should strengthen the value of a currency.
Raising rates is a way to get individuals and businesses to spend and borrow less and save more, as the cost of major purchases (such as houses and cars) on credit becomes more expensive. This is meant to cool down inflation and the wider economy, making it more stable.
“The immediate effect is a stronger currency as investors looking for a safe investment flock into a country with higher rates,” says Yohay Elam, an analyst at FX Street.
Joshua Raymond, director at financial brokerage XTB, agrees.
“Typically those currencies which attract a higher interest rate see more demand and appreciate in value as investors seek to recycle their funds into higher yielding bonds,” he says.
How would a rate rise affect the pound?
As inflation rises in a country, it can boost the underlying currency as markets preempt a rate rise. In October, the UK’s Consumer Prices Index, a key measure of inflation, showed a 12-month price rise of 4.2%, the highest rate since 2011. So is the pound benefitting?
“Although inflation is rising in the UK, it is also doing so in the Eurozone and the US due to a combination of soaring energy prices due to shortages, global supply chain issues caused by the pandemic, a labour shortage impacting many industries, and comparisons with 2020 when many prices were cut, so that in itself is not strengthening the pound,” says Jonathan Merry, CEO at MoneyTransfers.com.
“Currently, Sterling is hovering around a one-year low against the Dollar after falling in November when MPC defied the market expectation that it would raise rates. With interest rates near-zero in the US and Eurozone too, and central banks in both expected to raise them at least once next year, Sterling would need a first-mover advantage to strengthen against its main rivals off the back of a rate rise,” Merry explains.
Will the Bank of England raise rates in December?
Financial markets and analysts think it’s unlikely because of fears over the Omicron variant of Covid-19. The Bank will not want to create extra challenges for businesses going through a hard time, and there is also the wider context of energy prices causing inflation that will limit the short-term effectiveness of a rate rise.
“The Bank of England had long been expected to start hiking interest rates in December, with many calling for a rate rise last month ignored. Yet it seems the arrival of the new Omicron COVID variant has put a hold on this, with the central bank now forecast to hold rates at current low levels to take stock on the impact of a larger new Covid wave,” says XTB’s Joshua Raymond.
“Whilst it’s likely this new Covid wave will exacerbate supply issues and therefore add more inflationary pressure, it looks likely the central bank will not be able to refrain from hiking interest rates for much longer. Therefore, the market impact could be quite muted.
“Current market consensus is that we are likely to see UK interest rates hit around 1-1.25% by the end of 2022,” Raymond adds.
Yohay Elam at FX Street expects an initial rate raise in February.
“Clarity about Omicron and the US Federal Reserve’s steps are due by then, allowing the London-based institution to tighten its policy with fewer clouds hanging above it,” Elam says.
The Bank’s final decision of the year is expected on Thursday, the 16th of December.
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