Interest rates: What are they and why do they matter?

The Bank of England will decide today to raise interest rates or keep them at 0.5%.

It comes a day after the US Federal Reserve raised interest rates for the first time since 2018.

Many economists expect inflation to reach 7% this year, which would be its highest level since March 1992.

In the UK, interest rates peaked in 1979 at 17% during a period of high inflation and high unemployment. It is unlikely that they will reach that high this time.

A few weeks before the Russian invasion of Ukraine, the Bank expected inflation to top 7% this spring before tapering off.

Since then, global energy prices have soared, with Brent crude oil prices hitting a nearly 14-year high at one point. It can now cost more than £90 to fill up a family car, according to the RAC.

Central banks often prefer to raise interest rates slowly to avoid market shocks, so few expect the Bank of England interest rate to exceed 1.25% this year.

But, last October, the Office for Budget Responsibility examined the impacts of higher and more persistent inflation and suggested that, in this case, UK interest rates could rise to 3.5%.

Setting interest rates, officially known as the Bank Rate, is one of the many ways the Bank tries to control the UK economy.

If interest rates rise, it can make loans more expensive, especially for homeowners with mortgages.

In addition to mortgages, Bank of England interest rates also influence the interest charged on other forms of credit, such as credit cards, bank loans and car loans.

So even if you don’t have a mortgage, changes in interest rates could still affect you.

Bank of England decisions also affect the interest rates people earn on their savings. Individual banks typically pass on any interest rate increases to their savers, giving them a higher return on their money.

Interest rates are decided by a team of nine economists, the Monetary Policy Committee.

It meets eight times a year, approximately once every six weeks, to discuss the performance of the economy.

Their decisions are always published at 12:00 on a Thursday.

If interest rates go up, the intention is to encourage High Street banks to raise the rates they charge borrowers. This has the effect of slowing down economic activity: people are less likely to borrow spending money if they know it will cost more.

Higher interest rates mean people earn more on their savings, which should encourage them to save rather than spend.

Encouraging people to do this should slow the rise in the prices of everyday goods. With fewer buyers in the market, sellers will find it difficult to raise their prices.

On the other hand, lowering interest rates makes it cheaper to borrow money and people get less return on their savings. The goal here is to encourage people and businesses to spend or invest.

The Bank of England raises or lowers interest rates to help maintain its 2% inflation target.

Inflation is the rate at which prices rise: if the cost of a £1 jar of jam rises by 5 pence, then jam inflation is 5%.

If prices, sometimes known as the cost of living, increase by more than 2% per year, the Bank will consider raising interest rates.

After the 2008 global financial crisis, the Bank of England feared the economy would collapse, so it lowered interest rates to 0.5% in 2009.

In 2016, it cut rates as the UK faced uncertainty following the referendum to leave the European Union.

And in 2020, it cut interest rates to their lowest level of 0.1%, as Covid caused the biggest economic slowdown in centuries.

Do you have a tracker mortgage and now you will see your payments increase? Are you worried that rising rates could affect your finances? Email haveyoursay@bbc.co.uk.

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