Bank of England raises interest rates to 4% for first time in three years as inflation heads for 5%

The Bank of England has raised interest rates for the first time in three years, warning that inflation is set to climb to 5% by the middle of next year.

The Bank Rate rose by 0.25 percentage points to 4%, a blow for households across Glasgow and Scotland with mortgages and loans.

"An increase in Bank Rate is warranted"

Governor Andrew Bailey said: "There is now enough inflationary pressure in the pipeline caused by the rise in energy prices, that an increase in the Bank Rate is warranted."

He also signalled that at least one more rise should be expected, although he cautioned against assuming a long series of hikes.

"Today's increases shouldn't be seen as the first in an inevitable long sequence of hikes. But, unless the conflict in the Middle East is resolved neither does it seem likely to be the last increase," he said.

Financial markets are expecting rates to peak at 4.9%.

Energy prices driving inflation

Inflation hit 3.5% in September, well above the Bank's 2% target, driven largely by rising energy and fuel prices.

Petrol and diesel prices are 30% and 40% higher respectively than before the US-Iran war began at the end of February. The closure of the Strait of Hormuz and attacks on energy facilities across the Middle East have also pushed up household energy bills.

The Bank expects Ofgem's energy price cap to rise to £2,150 in January, up sharply from its current level of £1,720.

Mortgages already higher

Markets had already priced in rate rises, and the average two-year fixed mortgage now sits at around 6% – up one percentage point since the war began.

For homeowners coming to the end of a fixed deal, that means significantly higher monthly repayments. Tracker and variable-rate borrowers are likely to see their payments rise almost immediately.

Food prices and the wider economy

So far, the Bank says high energy costs have not yet fed through to other prices and wages, partly because firms have absorbed the costs and many use hedging and fixed-price energy contracts. But it judges that fixed contracts ending and energy price rises since July make it more likely that businesses will start passing on higher costs.

Fears of a jump in food prices have proved unfounded so far, but the Bank expects food inflation to rise to 4.8% next year, driven by energy costs and the impact of the current El Niño weather event.

On the plus side, the Bank says the economy has been more resilient than expected. It now forecasts growth of 1.6% this year, slowing to 1.2% in 2027. But stronger growth means less slack in the economy to absorb price rises.

Worst-case scenario

The Bank also modelled a scenario in which energy prices stay high and oil reaches $130 a barrel for a sustained period. In that case, it warns, inflation could rise as high as 6.2% next year.

What it means for you

Savers may see slightly better rates on easy-access accounts, but borrowers face higher costs. Anyone worried about mortgage or debt repayments is advised to speak to their lender early, or seek free advice from organisations such as Citizens Advice Scotland or Money Advice Scotland.