Inflation & Interest Rates Explained: Why Prices Rise, Why Bank Rate Moves, and Why Mortgages Don’t Track It Cleanly
Key Points
Inflation is the speed at which prices are rising, not the price level itself— and your lived inflation can differ from the headline.
The UK’s Bank Rate is a lever to cool or stimulate spending, but it works with delays and through several channels.
The “headline → your wallet” route is not direct. It runs through wages, jobs, credit, confidence, and supply chains.
Fixed-rate mortgages usually move based on market expectations (swap-rate reality), not just the bank rate decision of the day.
Trackers and some variable rates respond quickly to Bank Rate changes; fixed deals often move earlier — or later — depending on expectations and competition.
Second-order effects matter: house prices, business investment, and government debt costs can shift the story months after the first rate move.
If you can remember one mental model, remember this: policy rate → expectations → market rates → lender pricing → spending/jobs → inflation.
Background
Inflation is the general rise in prices over time. In practice, it means the same basket of everyday goods and services costs more than it did a year ago. But that “basket” is an average. If you spend a lot on rent, energy, commuting, or childcare, your personal inflation can feel very different from the headline number.
Two simple ideas clear up most confusion:
First: inflation is a rate of change. If inflation falls from 6% to 3%, prices are still rising — just more slowly than before.
Second: your inflation is not the nation’s inflation. The official index is built from a representative basket. Your real basket has its own weights, and those weights change when you switch brands, cut back, or substitute.
That’s why inflation often feels unfair. It is “national” in measurement but personal in impact.
How inflation actually rises
Inflation is not one thing. It’s a family of pressures that can stack up.
1) Demand runs ahead of supply
If households and businesses try to buy more than the economy can comfortably produce, sellers get pricing power. You see it in fully booked services, tight labour markets, and “we can’t keep up” backlogs.
This is the classic “demand boom” story. It can start with strong wage growth, easy credit, tax cuts, a burst of optimism, or pent-up spending.
2) Costs jump, and prices follow
Sometimes prices rise because costs surge: energy, fuel, imported components, shipping, raw materials, rent, or wages. Businesses then pass some of that cost on to customers.
This phenomenon is why inflation can rise even when demand is weak. It’s not always the public that “spends too much.” Sometimes it’s the economy being hit by a bigger bill.
3) Expectations harden
If people expect higher prices next year, their behaviour changes now. Workers push harder for pay rises. Firms raise prices sooner. Landlords and contractors build bigger uplifts into renewals. Inflation becomes partly self-fulfilling.
4) One-off shocks create long shadows
A sharp shock can lift prices quickly — then the rate of inflation can fall later without prices returning to where they were. That’s why “inflation is coming down” can feel like a technicality when your weekly shop still costs more than it used to.
A useful rule: inflation is sticky when it spreads from a few items into wages, services, and expectations. That’s when it stops being a headline and becomes a habit.
How interest rates actually work
An interest rate is the price of money over time. Higher rates reward saving and make borrowing pricier. Lower rates do the opposite.
In the UK, the Bank Rate is the policy rate set to keep inflation stable over time. It matters because it influences the rates households and firms face — mortgages, loans, credit cards, business finance, and savings — but rarely in a neat, immediate way.
Two details explain most of the “Why doesn’t this process work instantly?” frustration:
There are lags
Rate changes work with delays. People don’t refinance their mortgage the next morning. Firms don’t cancel investment overnight. Wage deals roll through over months. Rents reset on tenancy cycles. The economy turns slowly because contracts and habits are sticky.
The central bank steers expectations, not just today’s rate
Markets don’t only react to the number. They react to the path they think comes next. If a rate rise is expected and already “priced in”, the announcement may change little. If it surprises, it can move markets sharply even if the change is small.
This leads us to the section that most guides tend to overlook.
The Transmission Map (the chain you can replay in your head)
Here’s the mental model. Read it from left to right.
Bank Rate decision → expected path of future Bank Rate → money-market rates & swap rates → lenders’ funding/hedging costs → mortgage and loan pricing → household & business spending → jobs and wage growth → inflation
Now, what each link really means:
Bank Rate decision
This is the visible headline. But it’s the first domino, not the last.
Expected path of future Bank Rate
Markets immediately ask: Is this the start of a series, or a one-off? The answer matters more than the single move.
Money-market rates and swap rates
Swap rates are the market’s way of pricing what interest rates are likely to average over a period (two years, five years, and so on). This is where “fixed-rate reality” lives.
Lenders’ funding and hedging costs
Lenders don’t want to gamble on where rates will be. When they offer a fixed deal, they often hedge their risk. If the market price of that hedge rises, fixed deals tend to get more expensive — even if Bank Rate hasn’t changed yet.
Mortgage and loan pricing
What you see on comparison tables is not a pure reflection of Bank Rate. It also reflects:
product competition,
risk appetite,
loan-to-value and credit risk,
operational capacity and pipeline volume,
and how quickly a lender wants to win (or avoid) new business.
Spending, jobs, and wage growth
Higher rates squeeze borrowers, cool demand, and usually slow hiring and wage growth over time. That’s the uncomfortable part: rate policy fights inflation by weakening spending power.
Inflation
Inflation tends to fall when demand cools and wage growth eases — but the timeline is messy, especially if price increases began as a cost shock.
Myth-buster box (keep this handy)
Myth: “Rates go up; inflation instantly falls.”
Reality: Inflation usually responds with delays, and some inflation drivers (like energy shocks) aren't concerned about interest rates in the short term.
Myth: “Fixed mortgages follow Bank Rate.”
Reality: Fixed deals usually follow expectations and swap-rate pricing. They can move before Bank Rate, and they can ignore a small Bank Rate change if markets already expected it.
Myth: “Inflation is just greedy companies.”
Reality: profit-taking can be part of inflation in some sectors and moments— but inflation is bigger than one motive. Demand, costs, wages, exchange rates, and expectations also move the dial.
Mini-tool: How to read a rate-change headline in 30 seconds
Use this quick checklist:
Was the decision a surprise?
If markets expected it, the real action may already have happened in fixed-rate pricing.What did the language imply about the following meetings?
The hint about the path often matters more than today’s move.Which rates move fastest?
Trackers and some variable rates tend to respond quickly. Fixed deals respond to swap rates and competition.Is inflation demand-led or shock-led right now?
Demand-led inflation is more rate-sensitive. Initially, shock-led inflation is less sensitive to interest rate changes.What’s the lag?
Assume months, not days, for the bigger effects (jobs, wages, broader inflation).
Mortgages can be categorised into three types: tracker mortgages, fixed-rate mortgages, and those influenced by the "swap rate reality."
This is where people experience the impact of the policy directly.
Tracker mortgages
A tracker typically moves in line with Bank Rate (often plus a margin). If Bank Rate goes up, payments usually go up quickly. If it falls, they usually fall quickly too.
Trackers are simple to understand: you are openly exposed to policy moves.
Fixed-rate mortgages
A fixed deal locks your rate for a set period. That certainty is valuable — but it’s priced.
Here’s the key: fixed mortgage pricing is typically built on market expectations over the fixed period, not purely today’s Bank Rate. If markets think rates will stay higher for longer, the cost of offering a fixed deal tends to rise. If markets think cuts are coming, fixed deals can fall even before Bank Rate does.
Why fixes don’t “track cleanly”
Fixes don't "track cleanly" because they represent a forward-looking bet, which lenders typically dislike. They price in:
Where the markets think rates are headed,
The cost of hedging that risk,
The market's willingness to lend aggressively also plays a significant role.
That’s why you can see this odd pattern:
Bank Rate unchanged, but fixed deals move anyway.
Bank Rate cut, but your fixed quote doesn’t improve much (because markets already priced it).
Bank Rate rises, but fixed deals had already climbed weeks earlier (because expectations shifted earlier).
If you want the cleanest mental shortcut:
Trackers follow Bank Rate. Fixes follow the market’s expectation of Bank Rate over the fixed term, plus the lender’s pricing strategy.
Here are some practical examples of what this means in daily life.
The same Bank Rate move can land differently depending on what you do with money.
If you’re on a tracker or variable rate, your monthly cash flow can shift quickly. That changes supermarket choices, holidays, subscriptions, and how cautious you feel.
If you’re on a fixed mortgage, you might feel nothing today — until you remortgage. Then you feel everything at once, because several years of rate expectations are compressed into one new deal.
If you’re renting, the impact often arrives through the slow grind of landlord costs and market rents. The impact is rarely linear and often lags behind changes in mortgage rates.
If you’re saving, higher rates can finally make savings interest meaningful — but only if it beats inflation after tax. And even then, inflation can still quietly erode purchasing power.
What changes occur first compared to last in a simple lag framework?
First (weeks to a few months):
Market pricing shifts, some savings rates move, tracker mortgage payments adjust, and confidence headlines change the mood.
Next (3–12 months):
Household spending cools, some firms slow hiring, investment plans get postponed, and wage pressure starts to ease.
Last (12–24 months):
Broader inflation trends become clearer, the labour market fully reflects the slowdown, and house prices adjust to the new affordability reality.
This is why rate policy feels blunt. By the time inflation is obviously falling, many households have already taken the hit.
Optional checklist: Is the result an inflation shock or a demand boom?
Answer yes/no:
Did inflation start with a narrow set of items (energy, food, shipping, imported goods)?
Are wages rising broadly after prices rose, rather than leading them?
Is consumer spending weak even as prices rise?
Are business surveys reporting cost pressure more than “overwhelming demand”?
Is the currency move or import costs a big part of the story?
More “yes” answers usually points to a shock-led episode. More “no” answers usually points to demand-led overheating. Mixed answers mean the messy middle — which is where most real life lives.
FAQs
Is inflation always detrimental?
Mild, stable inflation can be compatible with growth. The problem is high or unpredictable inflation, which makes planning hard and hits living standards.
Why not just cap prices?
Price caps can help in emergencies, but they can also create shortages, reduce investment, or shift costs elsewhere. They treat the symptom, not the engine.
Do higher rates always strengthen the pound?
Not always. Exchange rates move on expectations, growth outlook, risk sentiment, and international rates too.
Why do my prices still rise when inflation “falls”?
This is because the term "inflation falls" typically refers to a slowdown in price increases rather than a decline.
Does inflation wipe out debt?
Inflation can erode the real burden of fixed nominal debt over time, but only if your income keeps pace. If wages lag, inflation just squeezes.
Should I fix it or go to Tracker?
It depends on risk tolerance and budget slack. If a rate spike pushes you into stress, certainty can be worth paying for. If you have room to absorb swings, a variable rate can be a calculated risk.
Why do fixed deals sometimes drop before Bank Rate cuts?
Fixed pricing often reflects market expectations for rates over the next few years, not just the current setting.
What’s the simplest way to “beat inflation”?
There isn’t one. The practical approach is usually a mix: reduce high-interest debt, keep an emergency buffer, and invest for the long term if your time horizon allows.
Conclusion
Inflation is the rise in prices. Interest rates act as both a brake and an accelerator to help stabilise inflation. But the road between the two is long, full of junctions, and rarely smooth.
If you remember only one thing, make it this: Bank Rate is not your mortgage rate. It’s the first signal in a chain that runs through expectations, markets, lenders, and the real economy — and the delays are part of the design.
