Interest rates are rising, so what can you do about it?

History was made this week when, for the first time, the governor of the Bank of England had to write to Gordon Brown to explain why inflation had climbed to 1 percent over the 2% target set by the government.

Cap in hand, Mervyn King, the Bank of England governor, had to explain that the Bank of England was determined to bring inflation back down to 2% again. This statement looks ominous for interest rates, as we'll show here.

As powerful as it is, the Bank of England has only one weapon in its armoury to control inflation, and that is interest rates.

Squeezing demand for goods and services by raising the cost of borrowing slows down a rapidly growing economy, leading to lower inflation. Higher interest rates mean higher mortgage bills and loan charges so we, the consumers, are going to pay the price to lower inflation.

Why inflation is increasing

The UK has enjoyed a period of enormous growth and relative prosperity – the property market is booming and unemployment is generally low, although this figure is worsening slightly according to the latest figures.

As house prices have increased, people have felt more wealthy and have been prepared to borrow more using the growing equity in their houses as collateral. Increased borrowing results in increased spending on the high street so as demand for goods increases, their prices are rising too.

The borrowing boom is leading to a spending frenzy that is driving inflation up. The only way to stop this feeding frenzy is to make borrowing more expensive which thens slows everything down behind it.

Earnings are increasing

Average earnings are increasing at their highest rate for three years. Larger wage demands fuel inflation, which increases the chances of interest rate rises.

Although electricity and gas prices are coming down – albeit more slowly than they increased, which helps lower inflation, the increasing petrol prices exerts an opposite effect.

To add further fuel to the inflation fire, the resilience of property prices to previous interest rate rises must also be concerning the governor of the Bank of England.

Interest rates are only going one way, as a result – upwards.

How high will interest rates go?

Interest base rates are currently at 5.2 percent%. It is highly likely that they will increase again in May. Although analysts predict a 0.25 percent rise, we wonder if an 0.5 percent increase is on the cards.

Slowly increasing rates in 0.25 percent steps has not slowed inflation and reduced house prices and wage demands so far. A surprise leap by 0.5 percent may shock the nation into borrowing and spending less.

A rise of 0.5 percent to 5.75 percent may be nasty tasting medicine, but perhaps the Monetary Policy Committee, which sets rates, will think that this is the only way to cure the inflation illness.

If inflation continues its upwards trend, unfortunately we can expect further rate rises with 6 percent becoming a reality, maybe in the autumn.

So what can you do now?

It would be sensible to switch to a fixed rate mortgage before rates rise again, however you should ensure that you are not being hit with early repayment penalties with your existing mortgage.

If at all possible, it would be sensible to reduce your borrowing by paying back some of your loans and credit cards. If you have to borrow more then try and find fixed rate loans, although these are normally only for low loan amounts and for people with good credit histories.

Consolidating your debts might be sensible, depending on your circumstances, to reduce your overall interest charges. Above all, try and curb spending on non essential items, which is what the Bank of England wants you to do as this will stop inflation increasing further.

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