Why interest rates have gone up

Last week the Bank of England announced they're increasing the UK’s base rate from 0.25% to 0.5%.

We need to understand why interest rates have gone up. The idea of this is to try and slow the high levels of inflation in the economy right now.

Inflation happens when prices increase over time, and this is encouraged by excessive spending entering the economy. In simple terms, people are spending more so the value of our currency (£) is falling.

Therefore, in order to discourage further inflation growth, the economy needs to see less spending. The best way to do this is to increase the interest rate because the idea is that people will be less likely to spend as much.

An increased interest rate encourages people to save money in a bank account as they can get a higher return on their savings. However, this is very unlikely to be the case where the savings rate is 1/12th of the current inflation rate meaning that you will end up worse off for saving in a bank account!

The other idea is that as anyone borrowing (car loans, mortgages, business loans, etc.) will have to pay higher interest rates, they will have less spare cash available to spend freely within their economy. This results in less spending and should reduce inflation growth.

However, my worry here is that in a time where so many people are living month-to-month, with 41% of the UK population unable to survive without a single month’s income as they have no savings to fall back on, many will be plunged deeper into poverty.

Typically, this is why recessions follow periods of high inflation and result in the poorest people being worse off and hit the hardest. This is why I often refer to inflation as a tax on the poor.

How can we win?

Unfortunately, the only way to avoid being worse off during times of increased inflation and rising interest rate, is to invest in appreciating assets.

The British Pound is a depreciating asset as it is subject to inflation, meaning that the value in real terms falls over time. Considering that the GBP saw inflation of ~6% over the past 12 months, here are some appreciating assets and their returns over the same timeframe:

S&P500 Index Fund +15.5%

Microsoft Stock +24.5%

Apple Stock +27.8%

Ethereum +80.7%

What is the lesson here?

That if you aren’t investing in appreciating assets, you will not be able to grow wealth in real terms or beat the ever-growing inflation rates in the UK.

Check out our free guide on investing here.