Ignore the rate rise, worry about the forecast

Rate rises can squeeze households. But Thursday’s hike from the Bank of England – its first in more than three years – brings mixed fortunes, compared with the universally grim forecasts published alongside it.

Let’s start with the group you’d tend to worry about when rates go up: mortgagors.

They’ve already taken a hit

In the end, the Bank took a little more than eight months to raise rates after the outbreak of the Iran war in February – but financial-market traders knew what was coming. They immediately raised their expectations for the level of Bank Rate in the coming years, and it’s these expectations that affect the price of fixed-rate deals that dominate the mortgage market today. As a result, mortgage rates rose by about a percentage point, even as the Bank stood still. For a typical first-time buyer (with a £220,000 mortgage) that rise costs an extra £140 a month relative to deals on offer in February.

While we should spare a thought for the roughly one-in-eight households on variable rates, most mortgagors have been shielded entirely from rising rates by their aforementioned fixes. That means the full pain of higher rates will only be felt slowly as people roll off their fixes onto higher rates. That will be around 1.4 million households over the next year, and their collective repricing will push the nation’s mortgage interest bill to a projected £72 billion in 2027 – £9 billion higher than in our pre-war projections. Granted, that doesn’t sound great, but we already knew it was on the way. Thursday’s announcement itself changed very little.[1]

The forecast is where the real danger lies

The bigger story this week wasn’t the rate rise, it was the Bank’s new economic outlook. Inflation is now forecast to peak at 4.9 per cent next spring and not to get back to the 2 per cent target until the third quarter of 2028. That’s a full two years later than the Bank expected back in the halcyon days of February.

And getting inflation down won’t come cheap.  In the Bank’s forecast, it hikes interest rates to nearly 5 per cent (although it has been at pains to stress that this is not a guide to future policy). Higher rates mean that growth is now expected to average a feeble 1.1 per cent annual pace over the next two years. More inflation and less growth add up to a nasty outlook for pay. Private-sector earnings are forecast to fall by 0.5 per cent in real terms next year, meaning the average worker in 2027 is set to be paid £390 less in real terms than they were in 2025.

That squeeze won’t only affect mortgagors. Falling earnings will hit social tenants, renters, outright owners – anyone who relies on a pay packet. Next to that, the £100 Council Tax rebates announced in last week’s Budget look pretty small.

The vibes are deteriorating, fast.

Official forecasts have been coming thick and fast over the past month, and each one has brought a gloomier outlook. We started well in October, with the IMF boosting Britain’s near-term growth outlook and giving us a pat on the back for our prudent fiscal plans. But then, just a couple of weeks later, the OBR lowered the tone. As my colleagues pointed out on Budget night, its living standards forecast has the average Briton set to be just £400 better at the end of the 2020s than at the start (each of the previous five decades saw gains of at least £3,400). And this week’s forecast from the Bank is more worrying still, with an inflation peak more than a percentage point higher than the OBR’s. Add that into the mix, and the OBR’s meagre living standards growth could vanish entirely. The rates might be grabbing the headlines, but the forecast is the part I’ll be watching closely.

Simon is on Bluesky. This post originally appears on the Resolution Foundation’s Substack. 

[1] UK interest rates rose a little on the back of the Bank’s decision and publication of its Monetary Policy Report, but were broadly flat over the day as a whole.