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The Bank of England (BOE) raised interest rates by half a point to 5 per cent last week, with increasing calls for tougher action to fight persistent high inflation. Andrew Bailey, the governor of the Bank of England, said that the Bank thinks inflation - the rate at which prices are rising - will fall "markedly this year" but adds there are signs of it being "persistent".

Recent figures showed that inflation did not fall as expected and remained at 8.7% in the year to May. Bailey confirmed that the BOE thought it was “right” that they took this action to raise rates."

On the face of it, a 0.5% increase does not sound too drastic and actually leaves the UK with a bank rate that is still lower than historic averages. But it is painful for those who have been relying on cheap lending, and a Bank Rate that stood at just 0.1% in December 2021. 

The first to feel the impact will be around 850,000 mortgage borrowers with a tracker rate mortgage. The average borrower will be paying around £50 per month extra.

Those on fixed deals, where the interest rate stays the same for a set period, usually as an introduction to the deal, will see no immediate increase – but will have to be prepared for a significant increase in repayments if their deal is close to ending. The overall message is – the increase will mean it will cost you more to buy your home.

At the beginning of the year, the same pundits who were predicting recession were also certain that house prices would fall as interest rates rose. There have been blips within the housing market, but the forecast price falls have simply not occurred. As the pundits proved, it is impossible to predict the future, but it may be reasonable to assume that this latest rate hike will not be the one that changes the position. A shortage of housing, and an economic outlook that is actually more positive than previously, could mean that a house price collapse is unlikely.

If inflation doesn’t ease as anticipated, we may see further base rate rises becoming necessary. Some forecasts suggest that the Bank of England base rate could well go over the current 5%.

So, what can you do to protect your long-term finances and combat inflation?

1. Protect your retirement income
Inflation has an enormous impact on how long retirement savings will last. The income that seems more than adequate when you start your golden years can look less than generous after 10 years of inflation, and a recipe for misery after 20.  A basic level annuity will mean having the buying power of your income eroded every year. An inflation-linked annuity will start off providing a much smaller income, but one that keeps increasing over time. A drawdown pension – where your pension pot remains invested, and you draw down an income as you need it, is more flexible – but you will still need to take care to avoid running out of cash.

2. Avoid locking your cash savings away
Savers should benefit when higher inflation leads to the Bank of England increasing the Bank Rate. But beware – although the rates offered by savings providers are rising, they have not yet done so enough to come anywhere near inflation.

However, with the Bank Rate forecast to rise further and with savings deals forecast to follow, there could be better deals to be had over the next few months. Shop around for the best deal – and avoid locking your savings into a long-term deal, because it could mean missing out on much better rates in the near future. 

3. Look at your investment strategy
In an inflationary world, investing – where your cash is used to buy something which could appreciate in price – could be more rewarding than saving.

While inflation erodes the value of cash savings, it actually works to boost the value of some investments. But how should you invest? Bond investment becomes less attractive in times of inflation, as the income provided by bonds is subject to inflation.

Investors can protect themselves by buying index-linked bonds, where the interest paid rises in line with inflation. Some business sectors will suffer during inflationary periods. Oil and mining companies can tend to do well as rising commodity prices are good for their bottom lines. Utility groups often pay dividends linked to inflation.

However, inflation could be bad for others such as retailers and supermarkets, which may lack the ability to increase prices. Luxury goods may be shunned when households tighten their belts.

4. Secure a low-rate mortgage before rates rise
To avoid increasing interest costs which could mean that buying your home becomes difficult or even impossible, it makes sense to try and secure the lowest rate you can for your mortgage, fixed for the longest possible period.

5.  Get some expert help.
Managing money in inflationary times can be challenging – but the challenges can be much more manageable if you have an expert to call on, so talk to your financial adviser. If you don’t have one, see: Choosing a financial adviser | MoneyHelper