We have had a sustained period of low base rates. Between August 2008 and March 2009, the Bank of England’s base rate dropped six times from 5% to 0.5%. The Bank of England’s Monetary Policy Committee (MPC) kept base rates at 0.5% for the next seven years and five months until it announced a further cut to 0.25% in August 2016, following the Brexit referendum. This is the lowest base rate since the Bank of England was founded as the Government’s banker and debt manager in 1694.
Since 1997 rates have been decided by nine members of the Bank’s Monetary Policy Committee (MPC), which is chaired by the Bank’s Governor. Recent meetings have suggested that interest rates could rise in the near future, with some thinking this could be as early as November.
Many of our borrowings and savings are linked to the Bank of England’s base rate so what impact could a 0.25% rate rise have on our savings and borrowing?
The average easy-access savings account is currently paying 0.35% in annual interest. So for a balance of £10,000 you would receive £35 interest over the year. Even the best buy easy access rate of 1.26% would only provide £126 interest. Assuming that the full 0.25% increase is passed on to the savings account, then the rate would increase to 1.51% only providing an extra £25 a year, a total of £151 on a £10,000 balance.
The largest borrowings are mortgages, but 57% of borrowers are on fixed-rate deals, so they will not be affected immediately. 43% of homeowners are on variable or tracker rates, so repayments will increase.
According to Nationwide, if average mortgage rates of 2.56% increased to 2.81%, then the increase in repayments would be:
Any variable rate loans will also increase, but fixed rate loans will be unaffected.
The outlook for interest rates
Mark Carney, Governor of the Bank of England, has regularly spoken of small base rate rises and a gradual pace, so there is no expectation for interest rates to rise sharply into 2018.
A key reason behind this caution is due to the concerns over UK consumer debt levels. Since 2012 households have added to their debt mountain and the ratio of household debt to GDP is heading back towards the peak seen in the boom years before the financial crash.
In March 2012, total household debt stood at £1,518.5bn in today’s prices compared with £1,630.1bn in March 2017. So in the past five years household debt has increased by an inflation-adjusted rate of 7.3%. Over the same five-year period, wages growth adjusted for inflation (and excluding bonuses) was only 0.7%, so consumers are turning to credit to buy essential items.
Borrowing on loans, credit cards, overdrafts and second mortgages has rocketed. Making matters worse, many households have doubled up on their debts by getting into arrears on their monthly bills, especially council tax. Aggressive interest rate rises would put greater pressure on UK consumer debt levels and could cause significant repayment challenges.
In addition, the ratings agency Standard & Poor’s (S&P) has reported a warning that Britain’s economy may not be strong enough to support an interest rate rise following hints from the Bank of England’s policymakers that there could be an increase in the cost of borrowing next month.
Financial planning considerations:
Managing your borrowing:
Although no sharp increase is anticipated, it is worth being aware that the average monthly mortgage repayment of £679.74 would increase by £78.48 if interest rates increased by 1% – so it is important to assess your own affordability and be prepared. We recommend that wherever possible, debt should be repaid as soon as possible, making affordable overpayments wherever possible.
For clients on fixed rates, at the end of their current deal, you should expect to see higher rates than you have previously been able to find. If you are on a variable rate, you should consider taking a fixed rate to manage the impact of any further base rate rises and help to plan your expenditure.
If you have any questions about rising interest rates and how this may affect your financial planning, then speak to your Origen consultant.
Managing your savings:
Despite the prospect of an increase in interest rates, the returns on cash investments remain at historical low levels. Last month, we discussed rising inflation which will reduce the future purchasing power of your money. With inflation at 3.0%, unless the rate of interest on your savings is matching inflation, then you are worse off in real terms. As the table below shows, savings rates have been falling and over recent years have been below inflation.
UK Savings rates
Source: UK savings rates – www.swanlowpark.co.uk
If you are willing to take some investment risk for the potential of higher growth or returns, you may want to ask your Origen consultant about investing in funds with access to the asset classes of cash, bonds, commercial property and shares. We have a range of panelled funds available to suit different objectives and risk profiles and to help you get your money working harder. Whilst stockmarket investments can deliver negative returns over shorter time periods, over the longer term of five years or more, equity investments usually outperform cash investments.
In any tax year, you should save tax efficiently and make use of your ISA allowance which is £20,000 in this tax year. If you have not used your ISA allowance, we can help you and if you have existing Cash ISAs, you can transfer these to Stocks and Shares ISAs to suit your own investment goals and attitude to risk.
With stock market investments your capital is at risk and the value of your investments can go down as well as up, you could get back less than you’ve paid in. Tax treatment depends on individual circumstances and tax rules could change in the future.
Ask your Origen Consultant to see how you can get your money working harder to provide additional income or growth in a climate of rising inflation and low interest rates.
This article is for information only and is not to be taken as Financial Advice.