Interest Rate Hikes Will Make Climate Change Worse

Raising interest rates won’t just push Britain into a recession and make the cost-of-living crisis worse for working-class people — it will discourage badly needed investments in green energy, undermining the UK’s efforts to address climate change.

An explosive demolition brings down the Pulverised Coal Injection (PCI) plant at the Teesworks site on October 19, 2022 in Redcar, England. (Ian Forsyth / Getty Images)

The UK government has not had a very good few weeks. With the now-sacked chancellor’s “mini budget” last month and its plethora of irresponsible tax cuts for the rich, Liz Truss’s administration drove down the value of the pound. In response, the Bank of England hiked interest rates even faster and higher than previously predicted. Rates are expected to go up to 6 percent by next summer, with grave consequences — not just for families paying their mortgages and businesses borrowing to invest, but also for our fight against the climate crisis.

The theory goes that higher interest rates help bring inflation down by making credit more expensive across the economy and reducing the amount of money firms and families have to spend on goods and services, thereby slowing price increases. But our inflation is predominantly driven by external factors, most notably high gas prices resulting from COVID-19 supply issues and the war in Ukraine. Instead, the bank’s policy is likely to push the UK economy into a recession, without addressing the main underlying causes of rising prices. That also means higher costs of borrowing for the very investments we need to reduce our reliance on costly fossil gas, like wind farms and home insulation.

To compound the problem, higher interest rates discourage investment in clean projects more than dirty ones. Running renewables doesn’t cost much: they rely on free wind and solar energy instead of expensive fossil fuels. But building them in the first place does come with high initial costs, meaning they are particularly impacted by the higher costs of credit. Similarly, insulation and heat pumps need to be paid for up front, before they begin to lower energy bills for households. Demand for improvements like heat pumps is significantly influenced by the availability of cheap loans to cover the initial installation costs.

From this summer’s heat wave to Vladimir Putin’s gas war to our skyrocketing energy bills, 2022 has shown that we need to kick our fossil fuel addiction as quickly as possible. To get the UK on track with reaching net-zero carbon emissions by 2050, we need at least £30 billion in additional capital investment by the private sector per year by the mid-2020s. But private investment has been stagnant in the UK since before the pandemic, and higher interest rates, amid the dire economic outlook to which they are contributing, will only make matters worse.

The government’s plan is to rely on the private sector and financial markets to deliver this increase in investment. They’re betting that companies publicly disclosing how exposed they are to the risks of the climate crisis will automatically get investors and banks to direct finance toward green firms and projects. But these market-based solutions aren’t working. Despite a plethora of initiatives introduced in recent years, most notably the Task Force on Climate-Related Financial Disclosures (TCFD), banks continue to pour billions into fossil fuel projects while the UK continues to face a large green investment gap.

Climate-related financial disclosures are in reality designed to protect individual financial institutions from climate-related financial risks, rather than take seriously wider systemic risks to the financial system, or make sure money is being used to tackle the climate crisis. And they presume that climate-related risks can be quantified with precise numbers, when in fact the impacts of climate change are characterized by “radical uncertainty,” with figures likely to underestimate seriousness. Simply put, leaving it up to the market isn’t getting investment where it’s needed quickly enough.

To actually address these issues, UK regulators need to simultaneously address the risky lending toward fossil fuel projects and provide greater support for green investment. The Bank of England can increase capital requirements on climate-risky lending, making it more expensive to finance such projects, and in coordination with the Treasury and BEIS, could also provide cheap credit for green investments by repurposing an existing program called the Term Funding Scheme. The scheme would offer deeply discounted loans to commercial banks, on the condition that they lend toward green projects and pass on the lower borrowing costs to households and businesses.

Historically, it was a norm for central banks to use a variety of tools to steer credit away from harmful activities and toward desirable ones, including the Bank of England during the post–World War II recovery and East Asian central banks during the rapid development of their countries. More recently, too, the central banks of Japan, South Korea, and China have introduced targeted lending programs to specifically support green investments.

In response to subsequent crises, from the pandemic to the gas price shock, the government and the Bank of England have coordinated on economic interventions, showing that our institutions can tackle major challenges — when there is political will. The joint Treasury-Bank Energy Markets Financing Scheme announced earlier this month, which will provide £40 billion in emergency loans to energy firms that get into difficulties due to high and volatile gas prices, sets a precedent for a central bank intervention into the energy market. Yet the scheme is another Band-Aid, conceived merely to sustain the status quo by providing more liquidity to the failing energy market as it is, without accompanying measures to accelerate the transition to a more resilient clean energy system.

If the Treasury and the bank actively steered credit into clean energy and efficiency measures, it would reduce the UK’s energy reliance on foreign dictators and reduce the carbon emissions fueling the climate crisis. The Bank of England’s latest round of quantitative easing to protect the UK’s financial stability threatened by the aftermath of the “mini budget” shows that it could help tackle systemic threats like the climate and energy crises, too.

Ultimately, higher interest rates, be it for their supposed anti-inflationary role or to try to protect the international value of sterling from sliding further, will worsen the cost-of-living scandal while undermining the UK’s climate efforts. Ideally, the government and the bank would coordinate to control inflation and support those on low incomes through social security, while avoiding further interest rate hikes. But when interest rates do rise, a green Term Funding Scheme would enable the bank to get money to green projects with a secondary interest rate — helping to stave off the crises that, as well as our present, already threaten our future.