Some thoughts on the interest rate rise
The decision by the Bank of England to put up interest rates on Thursday has resulted in a lot of debate.
Did rates really need to go up yet? Was this the start of a series of rates rises or just a one-off event? What impact with the rate rise have for savers and borrowers?
At its meeting this week, which ended on Wednesday with the decision announced on Thursday lunchtime, the Bank of England’s Monetary Policy Committee voted by a majority of 7-2 to increase the Bank Rate by 0.25% to 0.50%.
This is the first UK interest rate rise in over 10 years. The last rate rise was back in July 2007. Since then, it’s been heading in a consistently downwards direction.
As late as mid-morning on Thursday, I was calling (incorrectly) that the Bank would keep interest rates on hold at 0.25%. I don’t think the economy is ready for higher interest rates just yet.
Speaking to Financial Planning Today magazine shortly after the announcement of the rate rise, I said:
“I’m surprised to see the Bank of England increase rates against a backdrop of a fragile economy and uncertainty around Brexit negotiations.
“We should keep in mind that this is the Bank returning rates to a pre-referendum emergency footing, rather than signalling the economy or banking sector are out of the woods yet. The Bank will need to be cautious about signalling any future rate rises, which could choke off consumer confidence and trigger panic selling on investment markets. The British economy is not yet ready for a serious rate rise.”
Something I think we need to keep in mind as we unpick this interest rate decision, is that it’s only a reversal of the emergency rate cut to 0.25% made last summer, following the EU Referendum. Whether or not we can view this as a start of a rate rise trend is yet to be seen.
Moving rates from 0.25% to 0.5% means we’re back to the post-global financial crisis emergency low rate levels.
And there’s no change with this interest rate cut to quantitative easing.
The MPC voted unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £10 billion. They also voted unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435 billion.
So unlike the US, where they are actively reversing QE now, and in Europe, where they are bringing it to a halt, in the UK the pace of QE remains unabated and the central bank is pumping even more new money into the economy.
Is this interest rate rise likely to mean further interest rate rises in 2018?
Commenting on the rate rise, Ian Kernohan, Economist at Royal London Asset Management, said:
“In a boost for savers, the Bank of England has raised interest rates for the first time in over a decade. A hike was expected, as was a split in the MPC vote, so the market was more interested in the messages from the latest Inflation Report. The Bank were keen to stress that any future increases will be limited, and subject to developments related to the process of EU withdrawal.
“At 0.5%, the base rate will still be at an extremely low level, having being held at this level for most of the period since the financial crisis. On the other hand, many borrowers will never have experienced a rate rise, so there will be some element of surprise. As long as interest rates rise very gradually from here, then with around 60% of mortgages on fixed-rate deals, the impact on household finances shouldn’t be too severe, and will be offset by any future fall in inflation.
Kernohan finished by saying:
“We assume that the MPC will raise rates slowly over the next two years, assuming a Brexit deal is visible by mid-2018, unemployment remains low and global growth holds up. With inflation set to fall next year as the impact of sterling devaluation wanes, the MPC will stop hiking if there are clear signs that the economy is slowing.”
So that’s the combination of factors to look out for to create the right environment for further rate hikes; unemployment staying low, global economic growth continuing, and a visible Brexit deal by the middle of next year.
Remove one, two or three or these elements, and there’s a good chance that 0.5% is as high as interest rates will go for another few years.
Also commenting on the rate rise, Trevor Greetham, Head of Multi Asset at Royal London Asset Management, said:
“It’s not often you can say that interest rates doubled today. Rate hikes are never popular with borrowers, but with base rates at only 0.5% and inflation at 3% there will be little pushback. We expect the Bank of England to wait and see before making further changes. As the Bank made clear in their statement, Brexit is still the elephant in the room and there are considerable risks to the economic outlook and to sterling, which sold off in the aftermath of the announcement.
“Nearly eighteen months on from the referendum, all options remain plausible. It’s hard to imagine a continued tightening of monetary policy in a disruptive no deal outcome, and in this scenario sterling could easily fall another 10 to 15%. On the other hand, if permanent single market membership becomes likely, or if we see a reversal of the decision to leave the EU, the Bank of England would be comfortable raising rates further. In this case, sterling would probably rise 10 to 15%.
“Rarely have investors and business decision makers seen such exchange rate uncertainty, with a 20-30% range for where the pound could be in 2 to 3 years’ time, dependant on closed-door discussions between politicians. “In our view, UK investors with a low appetite for risk should ensure the bulk of their investments are sterling denominated. Doing this should help to remove one particular source of uncertainty from the equation.”
That’s an important point from Trevor; in the past few months, a number of our clients have asked us about currency allocation within the portfolios we recommend. We typically allocate the bulk of investment portfolios to Sterling denominated assets, and that’s because our clients are UK resident, so this approach removes currency risk, or at least avoids introducing unnecessarily levels of currency risk, to investment portfolios.
The outcome of Brexit negotiations could have a big impact on the value of Sterling, one way or the other. Over the past year or so, we’ve seen what a devalued pound means for the FTSE 100 index, with its high level of overseas earnings resulting in a profit boost and therefore higher valuations for company shares.
A lower Pound Sterling is also a boon for exporters, who become more competitive when Pound Sterling is lower.
But what happens if, as Trevor expects, we see a 10% to 15% rise in Pound Sterling over the next couple of years? What does this mean for FTSE 100 index levels? Diversification is key here to manage this particular risk.
We also received a reaction Azad Zangana, Schroders Senior European Economist:
“The Bank of England’s (BoE) Monetary Policy Committee (MPC) has raised interest rates for the first time since November 2007, in a move that has been well-flagged in recent months. The interest rate has been raised from a record low of 0.25% back to 0.50%, where it sat for most of the past decade until the Bank’s decision to cut just after the Brexit referendum.
“Since the Brexit referendum, the UK economy has performed better than expected, while inflation has risen sharply, largely due to the depreciation in sterling. With inflation just shy of 3.1%, if it rises further, then the BoE may have to write to the Chancellor of the Exchequer to explain the circumstances of the overshoot, and what it is doing to return inflation back to target.
“The MPC was not unanimous in backing the rise in interest rates. Two of the nine committee members voted against the increase, highlighting that substantial risks remain for the economy.
“While many are asking whether this interest rate rise will have much of a negative impact on growth, the more important question is whether the MPC sees this as a one-off rise, or whether this is the first of many. This first rate rise will undoubtedly burden those that are struggling to make ends meet, but for the vast majority, it will have a small impact. That said, it is unhelpful when wages are struggling to keep up with inflation, and when growth is slowing.”
I think that’s the question we’re all asking this week; was that it or will the Bank of England go further and continue to hike interest rates, especially if price inflation continues to rise?
The Bank of England always forecast price inflation to top out at around 3%, and we know that this inflation is being largely driven higher by rising import costs, which higher interest rates won’t immediately change anyway.
In my opinion, going further with interest rate rises now could cause serious issues for a fragile economy, especially in the consumer economy where unsecured debt levels are worryingly high, and consumer spending seems to be falling this year; the various retail sales figures look distinctly unhealthy.
The Bank of England had to do something this week. They already face a credibility challenge when it comes to their previous forward guidance over rate changes which never materialised.
With the US Federal Reserve and European Central Bank already tightening their monetary policy, the UK’s central bank risked being alone in remaining on emergency terms with its own monetary policy.
That’s the wider, economic picture. But what does a rate rise mean for you, today?
If you’re a borrower, then a lot of course depends on the type of mortgage product you’ve got. My own mortgage is a discounted base rate tracker, so I’m £45.20 a month worse off as a result of the decision this week.
Financial information business Defaqto have pointed out that only those on variable rate mortgages will be affected immediately.
For existing customers the increase of 0.25% will mean an increase of £22 per month (£264 per year) on average, based on a typical existing mortgage of £180,000 with 20 years remaining.
For First Time Buyers the increase of 0.25% will mean an increase of £19 per month (£228 per year) on average, based on a typical FTB mortgage of £150,000 over 25 years remaining.
Defaqto point out that mortgage providers are constantly changing products to compete, and despite this rate rise there are still a great many good deals available.
Their research shows that 85% of fixed rate mortgage providers and 31% of variable rate mortgage providers changed their rates in the past month, the majority of them being rate increases, which suggests that this rate rise was widely expected and mortgage providers were getting in early with their own rate rises.
What should a mortgage holder do? Defaqto say the next step will depend on the type of mortgage you hold and the terms of that deal.
They advise that many customers will have penalty clauses if they change mortgage, which might cost more than any saving by doing so. However, if you’re coming to the end of a fixed rate deal or you’re on a variable rate mortgage, there are things you could consider that might reduce your overall monthly spend.
Commenting on the rate rise, Brian Brown, Defaqto’s Head of Insight for Banking & General Insurance said:
“The bank rate rise has been widely anticipated, by both mortgage providers and their customers.
“As the UK’s leading financial products rating company and supplier of data to comparison websites, Defaqto continually tracks changes in the mortgage market. Even without the base rate change, many providers had already begun to increase their rates, with most fixed rate providers increasing rates on at least some of their deals over the last month.
“Customers though don’t need to panic, as this was a relatively small increase. Any further rate rises are likely to be gradual and there is plenty of time to consider other options. We would encourage consumers to calculate the costs of switching their mortgage, even if they are not quite at the end of any penalty period. In particular those coming to the end of fixed rate deals and those on Standard Variable Rates should see a mortgage broker to discuss their options for their next mortgage deal.”
A quarter percent rise in interest rates shouldn’t push any mortgage borrowers over the edge financially, I hope. If rising interest rates are causing you financial difficulties, then UK Finance Head of Personal Eric Leenders has some good advice. Leenders said:
“Whilst this is a small rise from a historically low base, anyone who thinks they may find it difficult to manage their finances should always contact their provider as soon as possible to discuss the support that’s available to help them. With most mortgage and personal loan holders, as well as businesses and credit card customers paying a fixed rate, many will see no change while their current deal lasts.
“Given that lenders offering variable rates assess a customer’s ability to pay at much higher interest rates, most should be able to cope with any increases as they filter down. Lenders consider a number of factors when deciding how to respond to a change in the base rate, and in this competitive environment where it’s easy to switch providers, customers who are thinking about borrowing money should shop around to take advantage of the best deals on offer.”
For borrowers who have maybe never experienced a rate rise during their adult lives, this week will act as a good reminder that interest rates can go up as well as down!
Now is a good time to think about affordability; can you afford to keep up your mortgage payments if interest rates go to 2%, 4%, 6%?
Crunch those numbers and understand what it would mean for your monthly payments, and take some action now – maybe start overpaying your mortgage each month to reduce the outstanding balance, or bolster your cash emergency fund for a rainy day, or, in the most serious cases, look at downsizing to a more affordable property so you can reduce your mortgage balance. The best time to do this is before everyone else tries to do the same thing!
What about savers though? We’ve heard Bank of England governor Mark Carney say he hopes to see banks and building societies pass on this rate rise to savers!
If history tells us anything, it’s that banks are very good at passing on interest rate rises to mortgage borrowers, not so good at passing them on to savers.
Sally Francis, money expert at MoneySuperMarket, said:
“For savers the base rate increase will be welcome news. It may not mean huge interest increases now – especially as providers are under no obligation to pass it on unless the account tracks it – but it is certainly a move in the right direction.
“Consumers who have their savings locked in a fixed account will usually have to wait until the term ends before moving balances but the rates on fixed term accounts tend to be better than the variable equivalents. However, if the market improves and offers far better rates it might be worth accepting an interest penalty and switching, if that’s possible under the terms of your account.”
Something we always tell our clients when it comes to cash savings is that banks rely on apathy. Unless you actively review your cash holdings at least once a year and move to the most competitive accounts, you’re likely to experience very uncompetitive interest rates on your cash savings. So take some action, shop around and take advantage of the best deals.
Watch out for those fixed term savings accounts though. The interest rates might look slightly more attractive, but you can easily lose out if you tie up your money for a fixed term and interest rates start rising in the background.
Taking advantage of a six month or one year fixed term savings account is one thing, but when you start looking at three or five year fixed term bonds, I get a bit worried you might be missing out during that time.