Weekly update - Have interest rates reached a plateau or a false summit?

This week’s update is penned by Pierre Paul in our cash management team.

UK base rate is currently 3.5% since the last Bank of England (BoE) monetary policy tightening on 15th December. This is the highest base rate has been since October 2008, when it was 4.5% just before the beginning of the great financial crisis.

This time last year base rate was only 0.25% but the fight against inflation means base rate has ratcheted inexorably upwards so, the question is, has it peaked and will the next BoE move be to cut interest rates?

The key to answering this question lies with inflation. Put simply, if inflation starts to fall then the BoE should be able to at least stop raising, and eventually start to cut base rate. All things being equal, the BoE seeks to set base rate at a “Goldilocks” level, which means, metaphorically speaking, rates are not so high that they cool economic activity too quickly or too low that they heat up economic activity too much.

Inflation is currently 10.5%, which is way above the BoE’s 2% target. This is a big problem for the BoE and the bank’s credibility for a couple of reasons: -

  • First, when inflation is more than 1% above or below the official 2% target, which is measured monthly, the Governor of the Bank of England has to write an explanatory letter to the Chancellor of the Exchequer setting out the reasons for the divergence from target and the action being taken to bring it back into line. Inflation has been more than 1% over the 2% target since August 2021, which means a lot of letters from the Bank of England to the Chancellor.
  • Second, inflation above target means additional government costs. One of the simplest illustrations of this is index-linked gilts, which are a type of bond issued by the government to borrow money. This type of gilt pays interest based on the level of inflation – the higher inflation the higher the interest the government must pay.

So, you can see why the government takes a dim view when inflation is above target; its borrowing costs rise and it gets lots of repetitive letters from the Governor of the Bank of England.

High inflation causes lots of other problems. Obviously, it increases the prices we pay for pretty much everything. This then causes discontent everywhere, particularly among workers, especially those that have Union backing, leading to strikes which cause inconvenience and stress for people who rely on those services whether you’re a train commuter or need an operation at an NHS hospital.

So, where next for inflation and interest rates?

Last autumn, from 5th September to 24th October, saw the incredible seven weeks of Liz Truss’ time as Prime Minister with her Chancellor Kwasi Kwarteng. Her election campaign painted a picture of a person you could trust on all fronts, whether that was foreign policy or the domestic economy. Seemingly the only person calling out her dubious economic policy was her opponent Rishi Sunak – and he would, wouldn’t he? Of course, as we now know, he was absolutely right.

We have never known a time like it. Confidence in the government’s financial competence evaporated, causing gilt prices to plummet and yields to soar. The fall in gilt prices was a huge problem for pension funds, many of which were brought to the brink of collapse. Fortunately, the BoE stepped in to support the gilt market, which saved the pension funds. The Chancellor was replaced, Liz Truss resigned and Rishi Sunak took over as Prime Minister.

As an indication of the last three months’ volatility please see the table below:-


10th October 2022

30th January 2023

Base rate




1 Month Fixed




2 Month Fixed Deposit



3 Month Fixed Deposit



6 Month Fixed Deposit



9 Month Fixed Deposit



12 Month Fixed Deposit



Source: Bloomberg

As you can see, when Liz Truss was PM in October the interest rate for a 12-month fixed deposit was 5.39% even though base rate was only 2.25% whereas now, with Rishi Sunak in charge, base rate has risen to 3.5% but the 12-month rate has fallen to 4.60%.

This snapshot is designed to illustrate that cash deposit interest rates are sometimes more about what markets expect to happen as opposed to the reality of current financial markets. So, back in October the political upheaval meant financial markets were worried that base rate would have to rise far higher than predicted. Back to the here-and-now, the financial markets have calmed down but because inflation is still much higher than target the BoE is expected to announce another base rate rise as it concludes its next meeting on 2nd February.

That said, the Bank of England Governor, Andrew Bailey, speaking to Wales Media on 19th January said that a recent dip in inflation could be a sign that "a corner has been turned"1. He added that “the Bank was not trying to change market expectations that interest rates will peak at 4.5%” however, “the pandemic and the cost-of-living crisis meant a UK recession was still on the cards.”

So, if inflation is on a downward slope, it is possible that 12-month cash deposit interest rates may have peaked last October, and are still relatively good value, but may have reached a plateau from which the next direction will be downwards. Having said that, we don’t see any need to rush because even if headline inflation does fall it could be a slow process as higher wage demands will sustain core inflation over the longer term, meaning less scope for the BoE to cut rates to pre-pandemic levels.

Just like inflation affecting the price of baked beans, it looks like higher interest rates are here to stay…


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