- By Michael Rays & Faisal Islam
- Business Correspondent and Economics Editor, BBC News
The Chancellor has said the UK has „no choice” but to raise interest rates in an attempt to tackle rising prices.
Inflation – the rate at which prices rise – is „the number one challenge we face”, Jeremy Hunt said.
He said the government „will not waver in our support” for the Bank of England to „do whatever it takes” to reduce inflation.
Rising interest rates and mortgage costs weighed on UK economic growth in April.
Although the economy grew by 0.2%, housebuilders and estate agents had a „bad month”, the Office for National Statistics said.
Borrowing costs are gradually rising to 8.7% from December 2021 to the current 4.5% from December 2021 in a bid to reduce consumer price inflation – well above the Bank of England’s 2% inflation target.
In theory, raising interest rates means it’s more expensive for people to borrow and they have less money to spend. As a result, they will buy fewer goods, which will reduce the rate of inflation.
Rising interest rates mean higher monthly mortgage, credit card and loan payments for some. But higher rates should benefit savers — if banks pass them on to their customers.
Asked if he was following former chancellor John Major’s directive in 1989, Mr Hunt said: „Ultimately there is no alternative to reducing inflation if we want to see consumer spending, if we want to see businesses investing, if we want to see long-term growth and prosperity.”
The government has had no say on interest rates since the Bank of England was granted independence in 1997.
The UK economy expanded in April after contracting 0.3% in the previous month. In the three months to April, it fell 0.1%.
Strong trade in bars and pubs boosted growth, but the ONS said the construction sector had weakened as rising interest rates and mortgage costs made homebuyers more cautious.
As interest rates rise and more people come to the end of fixed-rate mortgage contracts, some lenders are withdrawing some mortgages from the market.
First-time buyers face higher prices, leaving some priced out, and renters also face higher costs as landlords sell.
As hiking rates force consumers to spend less — when their borrowing costs increase or rates on savings accounts increase — businesses are less likely to raise prices.
But that mechanism may become less effective over time.
Take out mortgages. In the early 2000s, more than seven in 10 residential mortgages were on variable or tracker rates and were immediately hit by rate hikes. Today, it accounts for 15% of homeowners. Even if it adds 1.8 million remortgaging this year, it’s still a few decades from now, and minority mortgage holders will suffer.
The impact of rate hikes is less likely and may take longer to filter through.
Equally, banks and building societies are reluctant to offer rate rises to savers this time around, as the Bank of England and angry customers have noted. This may partly reflect the restructuring of savings institutions’ margins after lower interest rates – but less incentive for customers to stash away spare cash.
Higher interest rates mean that businesses are less likely to offer workers a raise that matches inflation than in the past — but the labor shortage is less this time around.
Although interest rate hikes may be less effective this time around, as some economists fear, they will remain an important tool in the fight against inflation.
Ian Burns, who runs housebuilder Cameron Homes in Staffordshire, said people were „too cautious” and „taking too long to make decisions”.
„If we don’t have customers we can’t keep building houses.”
On Monday, two-year government borrowing costs rose more than in the aftermath of last September’s mini-budget.
Asked if this meant his plan was not working, Mr Hunt said: „We are in a very different situation than we were last autumn. International commentators, the IMF, think the British economy is on the right track.”
But the New Economics Foundation, a think tank that promotes social and economic justice, said the bank should hold off on raising rates further and wait to see the impact of its previous hikes.
Its economist Lukasz Krebel said that while UK wages are rising, they are still not keeping up with inflation, meaning people are poorer in real terms.
He said prices were rising because of supply-side issues, such as labor shortages and Russia’s invasion of Ukraine, which is driving up energy prices.
„The UK government and Bank of England need to address the fundamental weaknesses that expose the UK to such inflationary shocks – particularly by supporting investment in clean energy and developing reforms to reduce reliance on volatile fossil gas,” he said.
Labour’s shadow chancellor Rachel Reeves said the figures represented „another day in the book of this Conservative government’s poor low-growth record”.
„The facts are that families are feeling worse, we’re facing rising Tory mortgage penalties and we’re lagging behind on the world stage.”
Additional reporting by Raphael Sheridan
„Oddany rozwiązywacz problemów. Przyjazny hipsterom praktykant bekonu. Miłośnik kawy. Nieuleczalny introwertyk. Student.