Are Interest Rates Going up and What Happens If They Do?
Interest rates have been in a slump for months, and lots of us are now questioning when they’ll start to rise again in 2021 and going into 2022. There is no way of telling exactly when and what the Bank of England will choose to do to interest rates. But savers and borrowers alike can start planning for a potential rise in the near future.
Rock-bottom interest rates have been a common theme during the pandemic. Before Covid hit, the Bank of England base rate was already at a low 0.75%. Then in March 2020, the rate was slashed to 0.25% and then slashed again to 0.1% – the lowest the rate has been in the Bank of England’s 300-plus-year history.
This drastic measure has always been seen as a temporary response to a crisis. But now that confidence is returning, albeit with some uncertainty mixed in, many are asking when rates will start to climb again and what borrowers and savers should do to plan.
How are interest rates set?
The Monetary Policy Committee (MPC) at the Bank of England (BoE) decide interest rates in the UK. It is the rate that banks use to lend to each other. When the MPC and BoE want to boost the economy, they set the rate low to encourage the public to spend. When they want to bring down inflation, they increase the rate to encourage saving.
Although banks and lenders are free to set their own interest rates for borrowers and savers, they often use the base rate to guide their decisions.
When will interest rates rise?
The BoE announces the base rate eight times a year, which is about every six weeks. Here are the key situations that could prompt interest rates to go up:
- Inflation increases – If inflation continues increasing at pace, the BoE could increase the rate to encourage saving.
- Economy strengthens – If the economy shows resilience and growth, this could be a good reason to recover the rate.
- Unemployment reduces – Due to policy changes, the unemployment rate is now considered as part of setting the BoE base rate. If unemployment is low, the rate could be increased.
No one can second guess what the BoE and MPC will choose to do with the interest rate. However, in summer 2021, the BoE indicated that it did not plan to increase the rate until the economic outlook in the UK was more certain. This is because although inflation is rising and expected to continue doing so, the Bank believes this will slow once post-Covid spending pulls back.
What do interest rate rises affect and how could that impact people’s money?
Until we know when and if interest rates will increase, savers and borrowers should respond to the current low rates and prepare for a potential rise. Here’s how an interest rate increase could impact the money in people’s pockets.
Savings: Savers tend to suffer when interest rates are low. If the rate your bank offers you is below that of inflation, your savings will lose value in real terms – and this is the current situation for many savers. An increase in rate would be good news, as it could mean your savings begin to earn more money than they currently do. If you have cash in savings, you could shop around for a better rate. They’re hard to come by, but they do exist. Alternatively, you could consider investing to try to beat inflation. There are no guarantees that this strategy will pay off, and a financial adviser can help you choose which route best suits your appetite for risk and your savings goal.
Mortgages: If interest rates rise, mortgages will start to get more expensive. People with a tracker mortgage – one that directly tracks the BoE rate – will see an immediate rise in their repayments. Similarly, people on a Standard Variable Rate (SVR) will likely see an increase, but this will ultimately depend on their lender’s decision. Understandably, lots of people are scrambling to lock in a better mortgage deal while rates are low. Just 0.5% lower could knock thousands off the amount you’d pay in interest. If you’re near the end of your deal, now could be the ideal time to remortgage. Most lenders will let you secure a deal around three to six months before your current deal ends. But it isn’t always as simple as quitting your deal and jumping ship. If you’re still well within your deal’s tie-in period, you could find yourself paying hefty early repayment charges (ERCs) for switching. For some borrowers, a better deal is worth the penalty. ERCs are calculated as a percentage of your remaining balance and they typically reduce the closer you get to the end of your deal. Depending on your deal, the savings from a new mortgage could outweigh the fee, but you’ll need to crunch the numbers. Borrowers who cannot switch deals cost effectively and are worried about the impact of a potential interest rate rise should get financial advice. An expert can help you prepare for a changing interest rate, which could involve building up some savings to help you afford higher repayments later.
Small businesses: Interest rates can have a significant impact on businesses that are borrowing cash, whether these are business loans or credit card loans. An increase in rates could see you paying more for your loan, which would increase your overheads and put pressure on your cash flow. If you experience cash flow difficulties, additional pressure could impact your ability to attract investors. There are some ways to help protect your business. You may be able to speak to your bank to fix your interest rate or hedge your product, which involves switching to a fixed deal for a set period. It’s also important to assess how your suppliers or customers could be affected by interest rate increases. Suppliers, for example, could up their costs to help cover rising interest, which would impact your margins. You could hedge against this risk by increasing your prices or contractually agreeing with a supplier to fix supply prices, but you should seek advice from an accountant.
Pensions: Those looking to take out an annuity could benefit from a higher interest rate. An annuity is an insurance product that offers you a guaranteed income after you retire. Annuity providers will quote you a rate as a percentage, and this percentage of your pension pot is the amount they’d pay you every year. You want to get the highest rate you can. Annuity rates are linked to returns from gilts (government bonds), so rising interest rates could mean rising gilt yields and increasing annuity rates. A pension pot is one of the most important savings anyone has, and once you get an annuity, it’s fixed for life – there’s no way of switching. It’s very important to get financial advice before touching your pension.
Interest rates affect everyone’s finances. If you have any worries about your savings, loans or your pension, please get in touch with us.
This article first appeared on Unbiased.
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