The UK's rising interest rates could stifle economic growth and have adverse consequences for millions of mortgage holders.

Interest rate hikes usually lead to currency appreciation, but this wasn't happening for GBP/USD, which experienced a significant decline after the Bank of England (BOE) surprised the market with a larger-than-expected interest rate hike. In the Asian session on Friday (23rd June), the cable dropped to a daily low of 1.2696.

GBP/USD

The BOE raised interest rates by 50 basis points, taking them from 4.50% to 5.00%, reaching the highest since April 2008. This decision exceeded the market's consensus of a 25 basis point hike.

"The economy is doing better than expected, but inflation is still too high and we've got to deal with it," said Governor bank of England, Andrew Bailey. "We know this is hard - many people with mortgages or loans will be understandably worried about what this means for them. But if we don't raise rates now, it could be worse later... We are committed to returning inflation to the 2% target and will make the decisions needed to achieve this."

Market participants revised their projections for UK interest rates, expecting them to reach 6.00% by the end of the year, the highest level in two decades. However, such a significant increase in interest rates could adversely affect economic growth and millions of UK mortgage holders.

Research conducted by the National Institute of Economic and Social Research (NIER) indicates that over one million households, equivalent to around 4% of total UK households, may deplete their savings by the end of 2023. Additionally, higher mortgage costs could push the number of financially insolvent households to approximately 7.8 million, representing around 30% of total UK households. These circumstances were unexpected due to the extent of the interest rate hike.

"Rate differentials have been a tailwind for the pound in June, but enthusiasm has been replaced this week by concerns over the adverse impact of spiralling mortgage and borrowing rates for home-owners and households on consumption and the broader economy," said Kenneth Broux, a currency strategist at Société Générale.

"For the U.K., a low growth/high inflation mix, combined with an outlook for aggressive Bank of England easing next year, are reasons we remain cautious on the pound's prospects versus the greenback over the medium-term," says Nick Bennenbroek, International Economist at Wells Fargo.