The prospect of a rise in interest rates, perhaps by the end of this year, is looming large. But what it’s all about, and how could it affect you? Find simple answers to the most common questions below.

What are interest rates now?

The Bank of England base rate is currently pegged at 0.1%. It was reduced from 0.75% on 24 March 2020, just at the start of the pandemic. For several years prior to that, it had largely remained at the 0.5% mark.

Who decides what happens to interest rates?

The Bank of England’s Monetary Policy Committee (MPC) holds meetings eight times a year (roughly every six weeks) for its nine members to discuss whether to hold the base rate or move it up or down – and by how much. The MPC considers factors such as the rate of inflation, economic growth and the UK employment rate. Each member then has a vote, with the majority determining the outcome.

At the last interest rate meeting, on 23 September, the vote was unanimous to keep interest rates on hold at 0.1%. The final two interest rate meetings and announcements in this year fall on 4 November and 16 December.

Why might interest rates rise?

Interest rate rises are used as a tool for the Bank of England to curb rising inflation, the thinking being that, if the cost of borrowing increases, people and businesses will be less willing to take out loans for spending purposes, which would suppress demand and depress prices.

The rate of inflation for September stands at 3.1% – slightly down on August’s 3.2% but still running significantly higher than its 2% target, set by the government. Speculation has been mounting that there could be an interest rate rise before the end of this year, with further potential increases in 2022.

Speaking recently to an online panel organised by the Group of Thirty, an economic consultative group, the Bank of England’s Governor Andrew Bailey said that, while he believed the spike in inflation would be temporary, its climb could ‘be higher and last longer’ due to the current surge in energy prices (more on this below).

The labour market is also showing signs of being strong enough to withstand a rate rise. According to data from the Office for National Statistics (ONS) the UK employment rate in September stood at an estimated 75.2% which, while still below pre-pandemic levels, is 0.5 percentage points higher than the last quarter (February to April 2021).

Why is inflation rising?

Inflation – the cost of general goods and services – is being driven up by worldwide supply shortages following a return to trading after the Covid lockdowns.

The shortage of microchips, which has caused supply issues for items ranging from games consoles to on-board tech for new cars, has been a prime example. A shortage of new cars has, in turn, impacted the used car market which, according to figures from AutoTrader, were 21% more expensive in September compared to the previous month.

A shortage of staff in some sectors is also triggering subsequent rises in costs – the most recent and notable example being HGV drivers, which led to the recent dearth of fuel in forecourts across the nation. According to the ONS, the cost of fuel in September 2021 (at 134.9p a litre) was the highest recorded since September 2013.

Meanwhile, soaring wholesale gas prices have translated into a sharp rise in household energy costs just in time for the colder weather. Cheaper fixed rate energy tariffs have disappeared from stock entirely, meaning there are no savings to be gained from shopping around for a better deal.

What does an interest rate rise mean for mortgages?

One of the biggest concerns around a rise in interest rates is the potential impact on the cost of mortgages.

Homeowners with tracker mortgage deals should see an immediate change to their monthly payments, as their rate is directly pegged to interest rates.

In due course, a rate rise will almost certainly affect homeowners paying a standard variable rate (SVR) or discounted deal linked to an SVR, as lenders will adjust this independent borrowing rate too.

Borrowers part-way through a fixed rate deal won’t be affected by an interest rate rise until the offer ends, when they will revert onto their lender’s respective SVR.

However, a market expectation of a rate rise will feed into the cost of funding for lenders’ new fixed rate mortgage deals, according to David Hollingworth at mortgage broker London and Country.

He said: “We have already seen some signs of fixed rates increasing and, although competition should help to maintain some attractive deals, it looks like the reductions in fixed deals enjoyed by borrowers in recent months may be coming to an end and even begin to reverse.”

The cost of fixed rate mortgage deals has been so cheap in recent months that, according to research by London and Country (October), borrowers could have been overpaying by up to £2,500 a year if they neglected to shop around at the end of their deal.

You can see what mortgage rates are available at our live table below, by selecting your circumstances and criteria.

What about for savings?

However, the prospect of an interest rate rise could already be having a positive impact on the savings market.

According to the UK Savings Trends Treasury Report from Moneyfacts, the number of available savings accounts has grown to its highest level since the first lockdown in 2020 while, at 0.76%, the average rate on longer-term fixed rate bonds (more than 550 days) has surpassed 1% for the first time since June 2020.