Inflation in the UK remains above 10%, according to the latest reading of the Consumer Price Index, a fact which has confounded markets and led to interest rate expectations spiking.

The market is now anticipating three interest rate rises this year, which would take the Bank of England’s base rate to 5%. Before the release of the latest inflation data, the expectation was we would only see one more interest rate hike, possibly two. So there has been a considerable shift in sentiment.

WHY DOES THIS MATTER?

Higher interest rates potentially affect a wide range of personal finance matters. Probably the most obvious knock-on effect is on the mortgage market, which will concern the millions of people rolling off cheap fixed-rate deals this year, who will face a much more punishing rate of interest when they come to remortgage.

Interest rates themselves don’t have to rise, simply the expectations of higher rates can push fixed-rate deals up, and we may start to see a bit of upward pressure in the mortgage market as a result of this latest inflation data.

Businesses are also adversely affected by higher interest rates. This increases the cost of servicing their debt, and also puts pressure on revenues, because higher rates also mean tighter consumer finances. This could put pressure on company profits and by extension, share prices.

Bond prices are also adversely affected by heightened expectations of interest rate rises. Indeed, the yield on the 10-year gilt (UK government bond), which moves in the opposite direction to its price, is now approaching 4% once again. That also heaps pressure on government finances, as the Treasury has to pay more to borrow as interest rates rise.

CAN HIGHER RATES BE GOOD NEWS?

Every cloud has a silver lining, and cash savers will be pleased at the prospect of an even higher return on their money, after more than a decade of deprivation.

The fact inflation still stands in double digits makes this a somewhat pyrrhic victory however, especially seeing as it’s proving stickier than anticipated.

Those who are looking to buy an annuity with their pension fund might also be in for a better deal, as these are priced based on bond yields. Again though, high rates of inflation erode the value of level annuities, which pay the same income year in, year out. You can buy an inflation-linked annuity, but it starts at a much lower level.

MIGHT INTEREST RATE PREDICTIONS BE WRONG?

While the market now appears to be pencilling in three more interest rate rises this year, this may not come to fruition. It’s very difficult to predict with any accuracy how the nine members of the Bank of England’s interest rate setting committee will vote at any one of their policy meetings. The market has been shocked by persistently high inflation, but as and when inflation starts to fall away, we might see a sharp reversal of market pricing.

The Bank of England’s forecasts already show inflation falling below its 2% target in the medium term, which suggests the interest rate hiking cycle is close to done.

The turmoil in the global banking sector also helps to cool the economy and lessens the need for interest rates to rise significantly, as does the gradual slackening we have seen in the labour market.

Some might conclude that current market expectations for three more interest rate rises this year is a bit of an overreaction to one month’s CPI reading. Inflation might be proving sticker than anticipated, but the market is still counting a lot of chickens before they’re hatched.

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