UK Interest Rates Forecast: Will Interest Rates Go Up or Down for the next five years?

In this article you will learn:

• How economists are forecasting UK Interest Rates could now remain between 5.25% and 5.5% by the end of 2023 or start of 2024
• The key changes to UK interest rates since 2021
• The economic outlook driving UK interest rates
• When the Bank of England expects UK inflation to fall to its 2% target
• Potential scenarios for UK interest rates over the next five years
• The impact of rising UK interest rates on mortgages
• What is inflation and how does it impact markets as well as central bank decisions 

The UK interest rates have been rising rapidly since December 2021 having hit record lows in August 2020 when the Bank of England (BoE) last reduced the base rate from 0.25% to 0.10% in response to the COVID-19 pandemic. Since then, rising inflation has dramatically changed the BoE’s interest rate stance with the UK’s Monetary Policy Committee (MPC) - which decides UK interest rates - voting to increase the UK’s base interest rate multiple times in an effort to curtail rising inflation, which is seen as a significant threat to the UK economy.

The last few months have seen dramatic changes in market expectations as to how high UK interest rates will go. At the end of 2022, economists were forecasting UK interest rates were likely to hit a high of around 4.5% within 12 months. That forecast increased significantly after data showed UK inflation was proving to be much more stubborn than expected with forecasts in June highlighting that UK interest rates could peak at 6.5% by Q1 2024. Today, those forecasts have receded significantly after a surprising decline in UK core inflation in August with most economists now expecting UK interest rates could rise between 5.25% and 5.5% by the end of 2023.

As you can see, UK interest Rate forecasts are constantly changing as more and more macroeconomic data is released. In this article, we explore the potential path of UK interest rates over the next five years, considering the UK’s economic outlook, the BoE's policy stance, the global context and latest developments to give you a complete overview of the UK interest rate situation.

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21st September - UK Interest Rates kept on hold at 5.25% in shock to financial markets. Is this the peak for interest rate rises? Latest Analysis

The BoE’s MPC kept UK Interest Rates on hold today in a big surprise to investors and economists who had largely expected the central bank to make a 15th consecutive rise in rates of 0.25% to 5.5%. The news sent the GBPUSD forex pair sharply lower to levels not seen since March 2023 as investors sold out of the pound in reaction.

Chart - The path of UK Interest Rates since 2014

Why has the Bank of England kept UK Interest Rates on hold?

The BoE has largely decided to adopt a wait and see approach when it comes to future interest rates after positive inflation data out yesterday showed price growth surprisingly cooled in August. The UK central bank has taken this as evidence that higher interest rates are already working enough to bring down price growth and it’s clearly concerned that further rate hikes might be deemed unnecessary at this time. More rate hikes hurt economic growth as it makes borrowing costs more expensive and encourages individuals to save money as opposed to spending it. Whilst this should help curtail the demand side effects that are driving inflation, it also saps economic activity and as such, the BoE is concerned that its efforts to bring inflation back under control could have broader implications for the medium term health of the UK’s economy. This is why the MPC is now hesitating towards making further interest rate hikes. That being said, it was a close call, with 4 out of the 9 members of the MPC voting to hike rates in today's meeting.

What does this news mean for UK Interest Rate forecasts?

Investors and economists alike are rapidly changing their interest rate forecasts in reaction to today’s BoE decision to hold interest rates at 5.25%. Before today it was broadly forecast that UK Interest rates would peak at around 5.75% by the start of 2024 and stay there until the second half of 2024 where we could start to see smaller rate cuts of around 0.25% to 0.5%. This would result in UK interest rates falling to around 5% by the end of 2024 and 4.5% by the summer of 2025. 

The latest UK Interest Rate forecasts have now changed with most economists expecting UK Interest rates to peak at around 5.5% before falling to around 4.75% by the end of 2024 and 4.25% by the summer of 2025.

XTB’s Chief Market Analyst Walid Koudmani commented:

“Today the Bank of England published its interest rate decision which seems to have been a "close call" as recent strong wage growth indicated that a hike was almost certain and the market was pricing the probability of such a move at 70%. However, yesterday's inflation reading caused the probability of a hike to drop.

The actual decision turned out to be a surprise - rates were left unchanged at previous level as 5 MPC members voted to keep them unchanged while 4 MPC opted for a hike while governor Bailey was among those who voted for a no change in rates. The central bank also decided to cut gilt-purchases by 100 billion GBP over the next 12 months.

While rates were left unchanged, the BoE cautioned that further tightening is required if inflation persists which leaves investors in a precarious position as GBP took a hit on the decision with GBPUSD moving to a fresh daily low near 1.2234. The key message today is that rates are at their peak or close to it but with current data, it could be a dangerous signal to send the markets since if inflation keeps running hot, the BoE will need to hike once more and will look like they are chasing the curve yet again. Everything will depend on data coming out in the next few months and while inflation has shown signs of slowing, it remains unclear if it will continue this downtrend or force the BoE to make an instinctive move.”

20th September - UK Inflation surprisingly falls in August to 6.8%. Could help convince the Bank of England to pause interest rate hikes

Data out from the Office of National Statistics today showed a surprising fall in UK inflation growth from 6.8% to 6.7% in August when most economists had forecast a rise to 7%. Importantly, core inflation - which strips out the more volatile items such as energy and food - cooled sharply to 6.2%, which far exceeded initial expectations. The inflation data raises hopes that the cooldown of price growth in the UK could start to accelerate.

What does this improved UK Inflation data mean for UK Interest Rate forecasts?

Most economists remain convinced that the Bank of England will still hike UK interest rates from 5.25% to 5.5% in tomorrow's MPC meeting (at 12 noon). That would result in a fifteenth consecutive interest rate hike, with rates at their highest levels since early 2008. There are however now more doubts as to the steps for UK Interest Rates thanks in part to this positive inflation surprise, as discussed by XTB’s Chief Market Analyst Walid Koudmani below:.

Walid Koudmani commented:

“Make no mistake, this is a positive surprise. UK Inflation continues to see higher prices than most of the rest of the G7, which is a clear and present threat to UK economic growth. So the fact we are now seeing an accelerated cooling of core prices will do much to give the Bank of England pause for thought. 

The BoE now faces a tough decision; do they continue to hike rates to help maintain this cooling of UK inflation or pause interest rate hikes to see which way the data points in the coming months? There is no easy choice because it’s clear from the data that UK inflation retains some heat. Average UK earnings remains at record levels and can help seed second round effects of high inflation which has the ability to keep price growth higher for longer. Nevertheless, higher rates damages economic growth and we’ve already seen substantial interest rate hikes already throughout 2023. It was claimed - by me and many others - that the Bank of England was far behind the inflation curve at the start of 2023. There is every chance that if they decide to continue to raise UK Interest Rates now that inflation has started to cool faster, they could be accelerating past the curve.”

Chart - UK Inflation surprisingly falls in August to 6.7% which could help convince the BoE to take a pause from hiking UK Interest Rates

Chart - UK Core Inflation (which excludes volatile items such as energy and food) cooled sharply to 6.2%, adding weight to the argument that the Bank of England might refrain from further interest rate hikes above 5.5%

12th September - UK wage growth continues to grow at record pace of 7.8%, increasing chances of higher UK Interest Rates in September

Data out from the Office of National Statistics on Tuesday 12th September highlighted the sustained pressure that wage growth may be having on UK Inflation. Annual growth of average pay excluding bonuses remained unchanged in July at 7.8%, which is the highest pace of wage growth since records began in 2001. Total pay including bonuses rose at a pace of 8.5% with much of this boost coming from pay settlements with NHS and civil service workers to end their respective strikes. However, this pay growth of 8.5% was stronger than economists had expected, with much of the market forecasting an unchanged reading of 8.2%. 

What does this strong UK Wage earnings data mean for UK Interest Rates?

UK Interest Rates are widely predicted to rise from 5.25% to 5.5% when the Bank of England’s MPC next meets on 21st September 2023. If economists were looking for clues which might convince members of the MPC to pause its current interest rate hiking cycle, this set of wage data didn’t provide it. Wage growth adds further upward pressure to inflation as it increases business costs which ultimately get passed onto consumers in the form of price rises. This is why the Bank of England takes wage growth data seriously in its economic outlook. Importantly however, wage growth is now outstripping inflation meaning the average worker is finally seeing a change in their real income, something not seen for many years outside of the Covid era. 

That being said, the UK unemployment rate rose - as expected - to 4.3% with around 207,000 people out of the workforce in July which was slightly more than expected. This ultimately may give economists confidence that wage growth at current levels might not be sustainable as with a rising number of people out of work, employers won’t have to offer the current levels of higher wages to attract talent for much longer.

16th August - UK Inflation slows to 6.8% in July but not enough to stop UK interest rates hitting 5.5% in September, analysts say

UK Inflation slowed to 6.8% in July, marking a continued cooling of UK inflation from the highs of 11.1% in 2022. Yet the slowdown was widely expected as most economists had forecast July should show UK inflation cooling to 6.8% thanks to a sharp drop in gas and electricity prices. On the outset, it's positive to see UK inflation remain in slowdown mode and cooling in much of the trajectory that analysts expect - having failed to cool in the speed most people had forecast in the first half of 2023. UK inflation is now at its lowest level since February 2022 and remains on track to hit around 5% before the end of 2023. 

Chart - UK Inflation continues to fall, with price growth cooling to 6.8% in July

Core Inflation continues to be a headache

The troubling aspect in the UK inflation data reading concerned Core Inflation. UK Core Inflation - which strips out volatile items such as energy and food - remained at 6.9% when price growth had been predicted to slow to 6.8%. Core inflation remains elevated with price growth remaining between 6.8% and 7.1% since April 2023, meaning prices continue to rise at a steady rate across many products and sectors. Now when you combine this aspect with the extremely strong UK Wage growth data out on 15th August, where wages grew by 8.2% and far higher than most economists had expected.

Chart - UK Core Inflation remains elevated and troublesome

What is the current UK Interest Rate forecast? And when might UK Interest Rates start to fall?

According to Bloomberg data, the market is 99% convinced that the BoE will hike UK interest rates by 0.25% to 5.5% when it next meets on 21st September. And what’s more, the market continues to price in at least 1 or 2 more rate hikes between November 2023 and January 2024, with UK interest rates expected to hit a peak of between 5.75% and 6%. The July Inflation data is unlikely to do much to deter the Bank of England’s MPC members from refraining from further interest rate hikes in the next three months. For the BoE to pause its current cycle of hiking UK Interest rates, it is likely we will need to see Core Inflation start to decline much more markedly than we have seen in recent months and UK Wage growth start to cool. Stubbornly high core inflation is an example of price rises becoming much more sticky and longer term whilst wage growth poses a threat to medium term inflation remaining elevated as business costs rise and  ultimately firms need to hike prices to maintain profit margins. Until the BoE starts to see those trends, it's very likely that UK Interest Rates will remain higher for longer. It’s for this reason that the market is not expected to see any UK rate cuts until well into 2024.

15th August 2023 - Record UK wage growth pace heightens chances of UK inflation running higher for longer

Data from the Office of National Statistics on Tuesday 15th August shocked the markets to print a record regular wages growth for the UK, with average earnings rising 8.2% in June from 7.2% in May (on an annual basis). That was far stronger than the market had expected, which was a smaller wage growth rise to 7.3%. Excluding bonuses, regular pay growth jumped to 7.8% against expectations of a drop to 7.4% (from 7.5% in May).

Chart - UK Average Weekly Earnings growth hits 8.2%

What does this wage growth data mean for UK Interest Rate forecasts?

Stronger than expected wage growth is a clear sign of secondary effects from rising inflation and further evidence that UK inflation is likely to stay higher for longer. In an effort to retain staff who are demanding more pay amidst the cost of living crisis, employers are having to offer higher wages to keep staff. By doing so, this increases the typical business operating costs which ultimately get passed to the consumer through rising prices, thereby seeding inflation into the UK economy more broadly and for the longer term. In essence, strong wage growth likely makes higher inflation stickier and therefore it forces the Bank of England to keep rising UK interest rates to help cool the demand side effects that it believes is a major part of what's driving UK inflation.

Markets are pricing in a 99% chance of UK Interest rates rising by 0.25% to 5.5% in September’s MPC meeting

It’s worth noting that on the back of stronger than expected UK wage growth data, the financial markets are now pricing in a 99% chance that UK interest rates will rise by 0.25% in September 2023 to 5.25%.

3rd August 2023 - UK Interest Rates rise to 5.25% in latest Bank of England move to curtail UK inflation

The Bank of England’s MPC moved to increase UK interest rates for a 14th consecutive time on 3rd August, by hiking rates to 5.25% - an increase of 0.25%. This increase was anticipated by the financial markets after recent UK inflation data showed prices had started to cool faster than expected. This latest rise means UK interest rates have now hit a new 15 year high. 

UK Interest Rates are forecast to hit 5.75% - 6% by end of 2023

The current forecasts by economists and the markets alike remain that UK interest rates are expected to peak at between 5.75% and 6% by the end of 2023 or start of 2024. UK interest rates are not expected to fall until mid 2024 and are likely to fall to around 4.5% by 2026.

25th July 2023 - UK Interest Rates are forecast to rise as high as 5.75% by the end of 2023 before falling in 2024 - latest predictions

The latest set of UK Inflation data - which showed that UK price growth in June was slowing at a faster pace than initially expected - has convinced economists and financial markets to re-evaluate their forecasts for how high UK Interest rates may rise in the next six months. Only a few weeks ago it was expected that UK Interest Rates would likely rise as high as 6.5% by the first quarter of 2024. Now those forecasts have been reworked and financial markets are predicting UK interest rates will rise between 5.75% and 6% by Q1 2024. 

Chart: Bloomberg Implied UK Interest Rates 

Here you can see how the implied UK interest rate has changed markedly in July (green line) compared to original forecasts in June (yellow line). As of 25th July 2023, UK Interest Rates are now expected to rise from 5% in July to a high of around 5.75% in January 2024. 

When might UK interest rates start to fall?

UK Interest Rates are now expected to fall towards the end of 2024 and well into 2025 after hitting highs of around 5.75% to 6% in the first three months of 2024. Economists are now expecting UK interest rates to remain around 5.50% to 5.75% for most of 2024 before starting to fall at the end of the year. UK Interest Rates are expected to fall by around 0.75% to 5% by mid-2025 and even further into 2026 where they are forecast to settle at around 4.5%.

When is the next Bank of England interest rate meeting and what are markets forecasting?

Below we list the key Bank of England MPC meeting dates and how interest rates might now rise at each meeting with the latest data:

• 3rd August 2023 - a rise of 0.25% could bring UK interest rates to 5.25%
• 21st September 2023 - a rise of 0.25% could bring UK interest rates to 5.50%
• 2nd November 2023 - a rise of 0.25% could bring UK interest rates to 5.75%
• 14th December 2023 - a rise of 0.25% could bring UK interest rates to 6.00% or the BoE could keep rates on hold at 5.75%

19th July 2023 - UK Inflation surprisingly slows faster than expected in June, increasing hopes that UK interest rates won’t need to rise to as high at 6.5% 

Data out on 19th July showed UK inflation cooled faster than expected in June, falling from 8.7% to 7.9%. Economists had predicted prices growth to slow to 8.1%. Core inflation - which strips out energy and food - also slowed surprisingly to 6.9% when the market had expected prices growth to remain at 7.1%. 

Why is it important to see UK inflation cooling?

It’s important on two fronts; first, because core inflation is finally coming down. Core inflation is seen as a better barometer of inflation because it strips out volatile items such as energy and food. So the fact that core inflation is now falling raises hopes that UK inflation may now start to cool off faster and broader than in the previous months. Second; this is the first data set out of the UK in many months which has shown inflation has declined faster than initially expected. Previously most UK inflation data and wage data has come in higher than economists expected. If we start to see inflation come in lower than forecast in the coming months, that will do much to change the guidance from the Bank of England and would raise hopes UK Interest rates won't need to go as high as 6.5%.

XTB’s Chief Market Analyst Walid Koudmani on whether this UK inflation reading might affect UK Interest Rate hikes:

“Make no mistake, this is a positive inflation reading but it's too early to warrant a dramatic change in forecasts for UK Interest Rates. Whilst it's great to see inflation fall faster than expected and core inflation is also finally falling, we cannot take one month of data in isolation. The general trend for UK inflation remains that it's much stickier than initially expected and as a consequence, UK interest rates will need to rise higher and faster to combat this. The market is still expecting UK interest rates to rise by 0.5% to 5.5% in August. I don’t believe the recent UK inflation data will change that outlook right now. However, if we do start to see July and August inflation data cool faster than expected with UK wage growth also pausing, that will do much to convince us that UK Interest Rates may not need to rise to 6.5% at the start of 2024.” 

11th July 2023 - UK Interest Rates forecast to rise to 6.5% by start of 2024

UK Interest Rates are now predicted to rise to 6.5% by the start of 2024 after another surprising jump in average earnings. Data out today, showed UK average earnings including bonuses rose by 6.9% in May against expectations of a smaller rise to 6.8%. Excluding bonuses, earnings jumped to 7.3% when a fall to 7.1% had been expected, reaching record levels after the previous month's rise was adjusted to 7.2%. 

What does higher average earnings mean for UK Interest Rate rises?

Higher than expected growth in average earnings paints a troubling picture as it shows inflation is becoming firmly entrenched in the UK economy with labour shortages forcing businesses to pay staff more to retain them against the cost of living crisis. This is known as secondary effects from high inflation and historically can result in inflation remaining higher for longer. 

What are the latest forecasts for UK interest rates and how high could they go?

The latest predictions from economists are that UK Interest rates are now expected to peak at 6.5% in the first quarter of 2024. This marks a stark change in tone from forecasts earlier in 2023 when UK Interest Rates had been expected to peak at around 4.5% by the end of the year. Below we list the keep Bank of England MPC meeting dates and how interest rates might rise at each meeting:

• 3rd August 2023 - a rise of 0.5% could bring UK interest rates to 5.5%
• 21st September 2023 - a rise of 0.25% could bring UK interest rates to 5.75%
• 2nd November 2023 - a rise of 0.25% could bring UK interest rates to 6.00%
• 14th December 2023 - a rise of 0.25% could bring UK interest rates to 6.25%
• 1st February 2024 - a rise of 0.25% could bring UK interest rates to 6.5%

How are the latest data affecting UK Mortgages?

IMPORTANT! The latest data shows average 2yr fixed mortgages have now risen to 6.6%, which exceeds the levels reached during the budget crisis last year. Average 5yr fixed mortgages are also now listing at above 6%. If you are looking to renew your fixed term mortgage deal in the coming months, you will likely face a significant jump in costs. 

Update - 22nd June 2023: UK Interest Rates rise to 5%. Could now hit 6.5% by end of 2023 / start of 2024

The Bank of England’s MPC (Monetary Policy Committee) increased UK Interest Rates by more than expected to reach 5% on 22nd June 2023, a rise of 0.5%. This was the 13th consecutive interest rate rise and the highest for 15 years as the BoE fights to cool UK inflation which continues to exceed economist expectations and remain high. Data out this week showed UK Inflation remained at 8.7% when it had been expected to cool to 8.4%. Importantly core inflation (which strips out energy and is seen as a better indicator of price pressures) rose to 7.1% in a surprising development when core inflation had been expected to remain at 6.8%. Thanks to these inflation figures, it was widely expected that the BoE would have to raise interest rates further.

With UK inflation remaining stubbornly high, economists now believe UK Interest rates are likely to hit 6.5% by the end of 2023/start of 2024.   

Why are the Bank of England raising interest rates?

The BoE are increasing interest rates in an effort to cool demand side effects to inflation. Higher interest rates increase the cost of borrowing and debt, meaning consumers have less of an incentive to borrow money for credit cards, loans or mortgages. Higher interest rates also means you earn more money for your bank deposits and bonds, so it incentivises you to keep money at the bank and not spend it. Therefore, higher interest rates are an attempt to cool prices by weakening demand. There is a debate raging however, that UK inflation remains high not simply due to demand aspects but thanks to continued supply shortages due to post-Covid and Brexit, which opens the possibility that the Bank of England cannot fight UK Inflation on its own and that there needs to be a combined effort with the UK Government in terms of optimising supply constraints to help bring inflation back down. Remember the Bank of England has a 2% inflation target which it must meet as part of its mandate.

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What is the impact on mortgages?

This week the average 2 year fixed mortgage rate hit 6% which was the highest level since December 2023. There is every expectation that average fixed mortgage rates will continue to rise with UK interest rates set to rise further and after UK 2-year Bonds Yields (Gilts) rose to 5.12%. This marks a significant rise since March 2023 when the same bond had a yield of 3.5%. With more than 400,000 fixed rate mortgages set to expire between July and September, these borrowers are set to suffer renewals at materially higher mortgage rates that they have been used to. 

IMPORTANT! Currently UK interest rates are forecast to peak at around 6.5% by the end of 2023 or start of 2024, which is far higher than initial predictions at the end of 2022, which were closer to 4.5%. Please consider how higher interest rates might affect your borrowing and mortgages.

What are the thoughts of XTB's Chief Market Analyst?

Chief Market Analyst Walid Koudmani commented: "There's been a dramatic change in the market view on UK interest rates in the last two months. At the start of the year, we had expected UK interest rates to reach around 4.5% by the end of 2023. Today, we now expect that UK rates could peak at 6.5% by Q1 of 2024 which marks a substantial material change."

So what's driving that change? 

He continued: "Simply put, UK inflation has remained far more stubborn than initially expected. Core inflation - which strips out energy - rose to 7.1% in May which was a shock. In addition, we are seeing a growth in average earnings which can be viewed as secondary effects of inflation i.e. workers demanding higher wages due to inflation. That has the effect of entrenching high inflation in the UK economy for longer, due to business costs rising and companies increasing prices to maintain profit margins. What the Bank of England is therefore attempting to do is hike UK interest rates aggressively in an attempt to dampen demand side effects, which are driving prices higher. Higher rates naturally make debt increase and encourages people to take less risk. BoE's plan A was to consistently increase UK interest rates. That plan has failed with inflation remaining stubbornly high despite dramatic falls in wholesale energy prices. So what's plan B? Plan B for the BoE is to aggressively rise rates more than the market had initially expected. They need to raise the bar. That's why we saw a shocking 0.5% rise in rates today, and why we should now expect stronger rate hikes going forward."

What about the impact on mortgages?

"It's not looking good. We know there are around 400,000 fixed mortgage deals set to expire in the next few months and those mortgage holders will inevitably be switching to deals at far higher rates than they are used to. We've already started to see hundreds of mortgages pulled from the marketplace due to credit institutions not wanting to take on extra risk given the clouded performance of the UK's economy and volatile debt markets (the yield on 2 year UK Gilts rose to 5.3% which is a new 15-year high). The average two year fixed mortgage rate is now exceeding 6% and with every rise in UK interest rates, those rates are expected to go even higher. We could be seeing an average 2-yr mortgage deal rise to 6.5% sooner than later"  Walid explained. 

Update - 13th June 2023: UK wage growth increases chances of UK Interest Rates rising to more than 6% by end of 2023

Data released on 13th June 2023 showed a strong growth in UK wages, with annual pay for all employees rising to 6.5% which was much faster than expected. Most economists had predicted wages to rise to 6.1%. What’s more, private sector wages grew by 7.6% which is a record pace outside of the Covid era. 

Why is wage growth data important when it comes to UK interest rates?

UK interest rates are rising as a key tool used by the Bank of England in their efforts to cool 40-year high UK inflation. By raising interest rates, the UK central bank expects that inflation should subside by cooling demand side aspects (by making borrowing more expensive and encouraging people to save money by earning higher interest on their deposits). This is why UK interest rates have risen from 0.1% in November 2021 to 4.5% in May 2023. 

The data concerning wage growth poses a risk to entrenching inflation further by heating the demand side aspects, as workers are earning more money and ultimately will likely spend more. That’s why on the back of this data, two year UK Gilt yields (the interest on UK bonds) rose to 4.81% which is higher than the levels reached after former Prime Minister Liz Truss’s car crash mini-budget. Thus highlighting the real expectation in the market that UK interest rates are expected to rise to 4.75% when the Bank of England’s MPC next meets on 22nd June 2023 with the financial markets now also projecting UK interest rates could peak between 5.75% and 6% by the end of 2023, which would be their highest levels since 2007. 

Update - 24th May 2023: UK Inflation in April cools to 8.7% but still exceeds BoE forecasts, increasing chances of more UK interest rates hikes

Data out on 24th May 2023 showed UK inflation continues to exceed expectations despite finally showing signs of cooling. In April 2023, inflation slowed from 10.1% to 8.7% which was a marked slowdown and mostly driven by sharp falls in wholesale energy prices. However, inflation had been expected to slow much faster to 8.2% and so the fact inflation continues to track above market consensus is having an impact on UK interest rate forecasts. The Bank of England has already indicated that should inflation fail to fall as fast as they predicted, the central bank has further room to hike interest rates in their efforts to bring inflation back towards its 2% target. With inflation now exceeding BoE forecasts in both March and April, economists and analysts alike are more convinced that we could see between 3 and 4 more rate hikes in the UK of 0.25%. This could mean UK interest rates could now hit 5.25% in 2023, which could have a significant impact for borrowers and mortgages.

XTB’s Chief Market Analyst Walid Koudmani commented, “The UK inflation data released today surprised many analysts, indicating a slower than expected drop which once again may be shifting expectations for the upcoming rate decision by the Bank of England. It has become increasingly likely that the BoE will raise interest rates more than previously expected to a terminal rate of 5,25% or even 5,50% in a desperate attempt to contain an inflation that has slowed much less than previously planned for.

However, it is important to note that due to a number of factors, inflation is still at a very high level, and it is likely to remain elevated for some time. While some aspects of the report showed promising signs, mainly due to the base effect, the situation remains quite pessimistic in the short term as a result of the noticeable impact the war in Ukraine and Brexit policies have had on the UK economy. The Bank of England now has a tricky task at hand, it is likely to continue to raise interest rates in an effort to bring inflation under control, but this could lead to a further slowdown in economic growth.

While the pound has failed to rebound following today's reports, with the GBPUSD pair still trading around 1,238, expectations of a further increase in interest rates by the Uk central bank may boost the pair in the future. 

In any case, it appears that the UK economy continues to be one of the worst performing of the G20 while we have seen a potential shift in approach from the FED and some uncertainty regarding the upcoming decisions by the ECB.”

Update - 11th May 2023: Bank of England Hikes UK Interest Rates to 4.5% - May 2023

On 11th May 2023, the Bank of England’s MPC raised UK interest rates yet again to 4.50%, a rise of 0.25% and lifting UK interest rates to their highest level since 2008. This rise was much expected by market experts and economists after recent data showed that UK inflation remained stubbornly high and had not subsided as fast as previously expected by the UK’s central bank. Inflation for March tracked at 10.1%, far higher than original expectations for a slowdown to just above 9% despite significant declines in wholesale energy prices. As a consequence, this forced the BoE to continue hiking UK interest rates and this decision marked its 12th consecutive rise in UK interest rates since December 2021. 

Comment from XTB’s Chief Market Analyst Walid Koudmani: 

“The Bank of England’s MPC today hiked UK interest rates yet again to 4.5%, a rise of 0.25% and lifting UK interest rates to their highest level since 2008.

This latest rate hike was much expected by the market and had been effectively priced to the strength of the pound after recent data showed that UK inflation remained stubbornly high and had not subsided as fast as previously expected. As a result we did see a small jump in the GBPUSD exchange rate yet this move was not significant given the rate continues to trade close to 1-year highs.

The market focus now turns to the future path of rate decisions and it's here where there remains a big question. We already know wholesale energy prices have collapsed much faster than initially expected, with spot natural gas prices trading 50% lower than in February with equally sharp falls in futures prices. This should quicken the pace of inflation cooling in the coming months which could convince the BoE to refrain from a thirteenth consecutive hike. But it should also be noted that food price inflation in particular remains stubbornly high, whilst wage growth and strong employment might keep inflation temperatures warm. In today's MPC decision, the committee admitted that it would have to hike rates even further if these conditions persist so that leaves the door ajar for more hikes.“

The key changes to UK interest Rates since 2021

Since December 2021, the BoE’s MPC has announced multiple interest rate hikes (rises) in an effort to help combat historically high levels of UK inflation, which rose to more than 11% and far exceeding the BoE’s target of 2%. Between December 2021 and May 2023, there has been 12 consecutive rises in the UK interest rate, which has pushed the base interest rate from a low of 0.1% in November 2021 to a high of 4.5% in May 2023, with the potential for further hikes now open for debate by economists and analysts. Some of the interest rate hikes have been significant, with the MPC voting to hike rates by 0.75% once and by 0.5% four times within this latest hiking cycle.

Chart - UK Interest Rates over the past 10 years

Source: Trading Economics

The Economic Outlook driving UK interest rate hikes

The BoE's Monetary Policy Committee (MPC) sets the UK interest rates based on its assessment of the economic outlook and the inflation risks. The MPC's primary objective is to maintain price stability in the medium term, defined as the two-year horizon. However, the MPC also considers the impact of its policy on the broader economy, including growth, employment, and financial stability.

The UK economy had suffered a severe contraction in 2020 due to the Covid pandemic and the associated lockdowns, but it has since emerged in a stronger shape as the UK economy and the global economy has opened back up. 

There are two major macroeconomic aspects influencing the current UK interest rate path; inflation and unemployment.

1. Inflation - a core KPI of the Bank of England’s primary objective is to target inflation at 2%, which is seen as helping to support stable growth and price stability. Unfortunately, UK Inflation has far exceeded the BoE's 2% target rate, reaching a 41 year high of 11.1% in October 2022 on the back of rising energy and food prices. The impact of the Russian invasion of Ukraine and subsequent economic sanctions has driven a near 130% jump in the price of gas, whilst electricity prices also rose by more than 60%. Food price inflation has also had a strong impact of overall inflation, with supply shocks remaining from the Covid pandemic and creating an imbalance between demand and supply of goods, pushing prices higher as a consequence.
2. UK Employment - the employment rate in the UK has remained stable at around 75%, which has resulted in a jump in earnings as employers have been forced to increase workers wages to retain staff amidst the backdrop of rising prices and a cost of living crisis in the UK. This has also played a role in keeping uk inflation high.

When does the Bank of England expect UK inflation to fall?

The BoE expects UK inflation to fall sharply this year from more than 10% to around 4% by the end of the year. They base this belief on three core factors:

• Wholesale energy prices have fallen quickly thanks to the UK and other developed economies building stable source of energy away from sanctioned nations
• Imported goods prices are expected to fall as many of the Covid induced supply constraints ease and the UK begins to import goods faster and at higher volumes
• Demand side spending constraints as consumers will have less money to spend due to rising costs, which should temper demand side price pressures 

Many economists and banks in fact expect UK inflation could fall back even more to just above 2% by the end of 2023. In February, Citigroup published a report which suggested the UK inflation rate could fall to 2.3% in November 2023 whilst Investec forecast inflation at 1.6% by December. Yet recent inflation data published by the Office of National Statistics (ONS) showed UK inflation remained stubbornly high in March, slowing to 10.1% from 10.4% when a sharper slowdown has been forecast by most economists. In April, inflation cooled to 8.7% yet was predicted to slow much faster to 8.2%, highlighting that UK prices remain hotter than most economists had hoped.

Chart - UK inflation over the past 10 years

UK inflation has traditionally ranged between 0% and 3% between 2013 and 2021. However soaring energy prices from the Russian invasion of Ukraine and supply issues helped to push UK inflation to record highs of 11.1% in October 2022. Recent months has seen UK inflation cool with prices slowing to 10.1% in March and 8.7% in April.  

Source: Trading Economics

Potential scenarios for UK interest rates over the next 5 years

Data compiled by Bloomberg have highlighted how in recent months expectations for higher UK interest rates have risen due to the fact UK inflation remains higher than forecast. The current plot graph indicates that UK interest rates could peak at or close to 5.25% within the next six months before falling sharply to around 4.5% by the first quarter of 2024. This is now higher than the implied UK interest rate merely a month earlier, which had originally expected to peak at around 4.5%. After hitting a new high of 5.25%, UK interest rates are expected to fall sharply in the coming two years with rates possibly between 3.5% and 4% in 2024 before falling to between 3% and 3.5% in 2025. UK interest rates are expected to stabilise between 3.0% and 3.5% between 2025 and 2027.

Chart - Bloomberg implied UK interest rates until 2027

Source: Bloomberg

The Impact of Rising UK Interest Rates on Mortgages

Rising interest rates can have a significant impact on UK mortgages, as they affect the cost of borrowing and the affordability of repayments. When interest rates increase, mortgage payments can become more expensive, which can put a strain on household budgets and affect the demand for new mortgages and housing.

Recently homeowners who have had to face remortgaging at significantly higher mortgage rates than their original deals as higher interest rates have driven a sharp increase in mortgage rates. Those owners who have seen their original fixed term deals expire in recent months have seen their new mortgage rates jump from less than 2% to more than 4% on average, which has added significant cost. Those on variable rates have also seen sharp increases in their mortgage costs each time the Bank of England has hiked interest rates since December 2021.

Rising interest rates can also affect the demand for mortgages and housing, as some borrowers may postpone their purchase or opt for cheaper properties or areas. This can have a knock-on effect on the property market, with lower prices, slower transactions, and reduced activity in related sectors, such as construction, renovation, and home improvement.