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The Bank of England has decided to raise interest rates by 0.25 per cent to 0.5 per cent, marking the first increase in a decade (that rise was from 5.5 per cent to 5.75 per cent, in case you are interested).
Higher than desired price rises, together with strong employment data, were behind the decision. Normally, an interest rate rise helps to strengthen the Pound – its value has been on a steady downward slide since the Brexit vote. However the Pound actually weakened slightly in response to the news yesterday, as the Bank suggested further rises would not necessarily follow quickly.
How this affects you will depend on whether you are mostly a saver, mostly a borrower, or a bit of both.
In basic terms, savers are rewarded by higher interest rates, and borrowers are penalised.
In reality, most people have some debt and some savings. The balance tends to tip more towards savings as you get older and pay off your debts.
If you are also the owner of a business that imports or exports, or an investor, the affect will be complicated further.
Mostly a saver?
Yesterday’s rise is the first cause for cheer that savers have had for some time, provided banks pass the full quarter point rise on to them – Nationwide declared early that it would apply the rise to all savings accounts, however, not all accounts will benefit – it’s best to check with your provider.
Mostly a borrower?
Conversely, personal loan, credit card and mortgage borrowers may see an immediate increase in their monthly outgoings as a result, if their borrowings are on variable rates.
The repayments on a variable rate mortgage on typical borrowings of £121,678, with an interest rate increasing from 2 to 2.25 per cent, would rise by £15 a month, from £516 to £531.
On a personal loan of £20,000, repaid over 5 years, a quarter point rate rise on a 3 per cent interest rate would result in a rise in monthly repayments from £359 to £362.
As the amount of consumer debt continues to rise, more borrowers may find themselves struggling to meet monthly outgoings in a climate of rising interest rates.
On their own, these increases seem manageable, but if you have a few credit cards, as well as a loan, overdraft and mortgage, they can soon feel painful.
How about for stock market investors?
“A gradual raising of rates is unlikely to hurt stock markets”, says Mark Taylor, chief customer officer at Equiniti. “Early indicators from the Bank of England suggest the likelihood of a rate rise has already been discounted into bond and equity prices in anticipation, so we shouldn’t see much disruption there.”
However, he adds that if a rate rise boosts the value of the Pound, he would be tempted to consider focusing his own investing in overseas companies that will benefit as a result, as well as domestically focused businesses. “Stronger sterling typically benefits importers such as airlines (due to jet fuel prices) and retailers, including computer and phone retailers. Banks (and financial/ insurance companies) also stand out as they will charge their customers more for loans and mortgages – but fail to pass on the rate increase to savers. The FTSE however, which has enjoyed a good run, may suffer given 70 per cent of its earnings are from overseas.”
Will rates continue to rise?
Knowing how over-stretched many borrowers are, it’s unlikely the Bank will continue to push for further rate rises until it can see the impact that yesterday’s has had on the economy. So, barring unexpected developments, huge hikes are not imminent.
Even so, you might want to think about how to organise your finances to protect yourself from the impact of rising rates should they increase more in the future.
Top tips for borrowers
*Make sure your debts are on the lowest possible rate.
*Fix your interest rate if you think you would be unable to cope easily with rate rises. Fixed mortgage rates tend to be higher because there is a slight premium for the extra certainty (the lender is absorbing the risk of future rate rises beyond what the money markets are expecting). But if you don’t think you’d manage two or three quarter point rate rises on a variable rate, a fix could be worthwhile.
*Overpay while you can. If you are comfortably managing your current debt levels, you could try reducing the debt more quickly by paying off more each month. Try rounding up your repayments to the nearest £100. If you get your debt as low as possible, when the rate rises come, you will have a smaller balance on which to repay the extra interest.
Top tips for savers
*Check what interest rates your savings are earning. Bear in mind that interest rate increases on accounts are at the bank’s discretion – they don’t automatically increase savings in line with base rate rises. Some banks and building societies offer tracker savings accounts, guaranteed to pay a minimum of a certain per cent above the Bank of England base rate. Using one of these means you will automatically benefit from a rate rise.
*There is a personal savings allowance of £1,000 of interest that can be earned tax-free each year. If you have a large savings pot, make sure an interest rate rise on your savings wouldn’t take you over this threshold. If it does, consider moving some savings into a cash ISA instead. There’s a £20,000 limit on ISA balances, on which you would not pay tax on interest or on capital gains.
*Review your investments. Changes to interest rates also have a bearing on the performance of other asset classes, such as equities, gilts and bonds. Rising interest rates can make the yield from bond funds less attractive, for instance. Stocks that tend to benefit when interest rates are higher are banks and insurers, but it can be difficult to second guess markets and investors may respond unpredictably to the first interest rate rise in more than 10 years.