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  • Writer's pictureSteve

What's all this about inflation and interest rates?

With so much talk in the press about inflation, and the never-ending changes to interest rates in the mortgage market, I thought I'd share this explanation that hopefully answers a few questions, in particular the one I've been asked a lot this week - "What the heck is going on??!!"




WHY DO INTEREST RATES AND INFLATION CHANGE?



The Bank of England (BoE) has announced another 0.5% rise in the base rate, taking it to a total of 2.25%.


We hear the words “rising inflation” and “higher interest rates” on the news, and they sound worrying, but most people don’t actually understand what they mean, and what effect they have on our lives.



SO WHY DOES INFLATION HAVE AN EFFECT ON INTEREST RATES?


Firstly, let’s look at what inflation means.


In simple terms, inflation means prices are going up. It could be caused by demand outstripping supply, or the cost of producing the goods & services has increased. In real terms, that means that you don’t get as much for your money.

The way this is measured is by using an average price of a basket of selected services and goods, which are typically bought or used regularly by the average British household. It’s called a “shopping basket”



WHAT IS A SHOPPING BASKET?


Currently there are over 700 items in the imaginary basket of goods.

Experts monitor the price of these goods and services, and track how their cost is changing. The tracking is commonly known as the Consumer Price Index.

If the cost is going up, this is referred to as increasing inflation.



SO WHY IS INFLATION GOING UP NOW?


Quite simply – it’s the cost of living crisis. It doesn’t just affect the UK, as many other countries are feeling the same pain we are!


As I touched on earlier, there are 3 common factors to inflation:


1) Supply & Demand – where demand is higher than the available supply

2) Product costs increasing is reflected in the “shelf price” of the product.

3) With price increases, wages *should* rise in turn, but as we know – they don’t!


So think about what’s happened in the last 2-3 years. Strains on production of goods, shortages of goods coming from the Far East, the pandemic, and now the situation in Ukraine & Russia. It’s almost like it has been planned – but that’s a whole other conversation!

In short, prices of everything are going up all over the world, so the world banks and governments have to try and steady things out, and one of the ways they do this is by increasing interest rates.




BUT WHY DOES INCREASING INTEREST RATES HELP LOWER INFLATION?


Because when interest rates go up, the idea is that it helps people stop spending as much and maybe start to save instead. If we stop spending, the demand drops and If the demand drops, the prices should follow.


It’s a fine balance though, which is why the MPC – Monetary Policy Committee, meet almost monthly to review the performance of the economy to decide if rates need to be increased, decreased, or left alone to see how it’s ticking over.



WHAT IS GOING TO HAPPEN IN THE FUTURE?


Ok, so the Bank of England aim for 2% rate of inflation. Obviously at the moment we are WAY off that, but they seem to believe that the rate of inflation will slow again, though the prices of some goods may remain high compared to previous cost.

They think that inflation should start to fall from 2023, and that's mainly because they feel it is unlikely that the cost of energy and imported goods will continue to rise as fast as they have been.


Similarly, as the impact of COVID slows down, supply of products should go back to normal, which should help bring prices back down.



WHAT DOES THIS MEAN FOR YOU?


Basically – we don’t know. There isn’t anything any of us can do about it as we have no control. It’s easy for governments to say “spend less” – I’m sure we’d all LOVE to spend less but we don’t control how much things cost!!!


We have to make savings where we can and for pretty much everyone, the biggest expense each month is your mortgage.


Now may be the ideal time to review your mortgage, especially if your fixed rate is ending in the next 6 months. Contact us now if you have concerns regarding your mortgage and the potential for rate increases. We may be able to help lock you into a lower interest rate before prices rise once more.



You may have to pay a repayment charge to your existing lender if you remortgage.

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