3 important implications rising interest rates could have for your finances
Interest rate rises have been a consistent theme in the headlines over the past 18 months. With inflation remaining stubbornly high, the Bank of England (BoE) is continuing the fight to bring price rises back to its 2% target.
But why is the BoE continuing to raise interest rates even as inflation begins to cool, and what could rising interest rates mean for you?
Keep reading to find out more.
Interest rate rises are a tool for fighting high inflation
In 2021, inflation began to rise sharply across the world. Compounding factors caused it to climb further throughout 2022 before beginning to cool slowly in early 2023.
The rise in inflation has been caused by several factors, including:
- Supply chain issues in the aftermath of the Covid-19 pandemic
- Energy and food shortages caused by Russia’s invasion of Ukraine
- Labour shortages caused by a rise in early retirement and long-term illness.
In the UK, inflation has stayed higher for longer compared to other developed nations – in June 2023 it was recorded at 7.9% compared to 3% in the US and 5.5% in the eurozone.
To reduce public spending and subsequently bring price rises down, the BoE has raised the base rate 13 consecutive times since December 2021. But the rate increases haven’t yet had the intended effect.
There are a few reasons for this:
- Changes to the base rate rarely have an immediate effect. In some cases, it can take 18 months or more before they influence consumer spending.
- The rate rises mostly affect the cost of borrowing, intended to squeeze mortgage holders so that they have less disposable income. But according to the Financial Times, 83.1% of mortgage holders have a fixed-rate deal, meaning that their repayments won’t be affected by the increase until they reach the end of their deal.
- The price rises in most sectors are being caused by factors that aren’t primarily influenced by consumer spending, so some experts have suggested that rate rises aren’t the most appropriate tool in fighting the current inflationary increases.
This has led some economists to predict that the BoE may need to make further rate increases in the coming months if it is to bring inflation back down to the 2% target.
Rising interest rates could affect 3 key areas of your finances
Everyone’s circumstances are different, so the effects of the interest rate rises will be individual to you. Broadly speaking, though, three key areas are likely to be affected.
- Cash savings rates should increase, but perhaps not as much as you’d expect
After several years of disappointing rates, banks and building societies are now offering much more competitive interest rates on their easy access savings accounts.
But before you make any hasty decisions about your savings, it’s important to consider these rates alongside inflation. Rarely do interest rates on cash savings keep pace with inflation – the highest rate on an easy access savings account as of 19 July is 4.51% – and some of the biggest high street banks have been criticised for not passing on the full extent of the interest rate rises to customers.
So, while your cash savings will likely have a higher rate of interest than they did a year ago, your money could still be losing value in real terms.
- Investment returns offer the opportunity to keep pace with inflation but uncertainty can create volatility
A well-balanced investment portfolio offers greater potential to see inflation-beating returns than cash savings, but there are risks involved.
During times of economic uncertainty, markets can become volatile. High interest rates tend to lead to lower consumer spending, putting pressure on the companies your money is invested in. It can also be more difficult for businesses to get loans to help them grow.
As with any investment, patience is key. Fluctuations in the value of your holdings are a natural part of investing in the stock market, so don’t let uncertainty spook you into making rash decisions.
- Soaring mortgage rates could mean that your repayments rise
Mortgage rates rose sharply following the mini-Budget in October 2022 when economic uncertainty caused volatility in the stock market. Rates fell slightly at the start of 2023 before rising again as inflation remained high for longer than anticipated.
According to Uswitch, as of 19 July, the average fixed-rate deals in the UK assuming a 75% loan-to-value ratio are:
- 6.8% for a two-year fix
- 6.29% for a five-year fix.
If you have a fixed-rate deal, your repayments won’t go up until you reach the end of the fixed period.
Nevertheless, figures reported by the Guardian suggest that 2.4 million homeowners are on a fixed-rate deal that will finish before the end of 2024. If you’re one of them, your repayments could increase significantly when you come to remortgage or if you are transferred onto your lender’s standard variable rate (SVR).
The SVR is set by your lender. It is ultimately up to your lender to decide when and by how much they alter the SVR – and, as a result, your repayments – so changes can be unpredictable. As of 19 July, the average SVR in the UK is 8.45%, almost double the average rate from June 2022, which was 4.91% according to a Guardian report.
If you have a tracker-rate mortgage, your interest rate will track the BoE base rate. So, each time the base rate increases, so will your mortgage repayments.
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If you have any questions about the current financial climate or its effect on your mortgage, speak to us now. Please email us at email@example.com or check with your adviser.
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
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