13th June 2014
Speculation about when interest rates will rise has been rife in recent months and Bank of England governor has added fuel to the fire, warning a rise could happen sooner than expected: so what will it mean for savers, investors, borrowers and retirees?
Interest rates have remained at an historic low of 0.5% for over five years. The Bank maintained in its ‘forward guidance’ that it would start to nudge up rates when unemployment hit 7% but as the rate dipped below that quicker than expected, it put off increasing the base rate.
Since then there have been a number of predictions about when the first rise would be. At first the end of 2015 seemed like a safe bet that that figure has drawn closer and now some analysts believe it could happen by the end of this year.
In a speech given to the City last night, governor of the Bank Mark Carney made uncharacteristically hawkish comments and warned the rise could ‘happen sooner than markets currently expect’.
Here’s how the rise could affect you:
Carney has already warned that any interest rate rise needs to be done slowly and gradually and markets are expecting small increases of 0.25% when rates do start to edge up.
He noted markets are pricing interest rates in at 2.25% in three years time and although he said there was no ‘pre-set course’ he said the economy is expected to reach a balance in that time and didn’t not say anything to suggest markets aren’t too far wide of the mark.
Homeowners are the main reason interest rates have to rise slowly. They are increasingly overburdened and any sharp rise in rates could do damage to those who have not fixed their mortgage rate. Two-thirds of people are currently sitting on their bank’s standard variable rate (SVR) and while they seem like good value now, they will start to inch up alongside rates.
Fixed mortgages rates have already started to increase so borrowers who are not on a fixed deal could be better off fixing the cost of their loan now rather than risking the impact of a rate rise.
Chris Williams, chief executive of online financial adviser Wealth Horizon, said: ‘Even the smallest move in rates could trigger a shockwave for those people who are already stretching the levels of what they can afford each month.
‘If they haven’t already, people need to start reviewing what impact a rise in rates will have on any debt repayments they might have, in particular their mortgage.’
Action to take: Williams said households should ‘aim to clear away as much debt as they can while rates remain low’ and put money aside to protect against further rises.
While interest rate rises are typically a signal of a recovering economy, and sterling jumped to a near five-year high this morning, the impact of rate rises will probably depend on what types of investments you hold.
Williams said Carney’s pre-warning was a signal to review asset allocation and the types of investment held in your portfolio.
‘When interest rates rise it can be a signal of an improving economy, however, fixed interest investments tend to suffer and with cash effectively becoming more expensive it can motivate equity investors to review their holdings, potentially taking profits off the table and selling stocks especially with markets at historically high levels,’ he said.
Action to take: Williams said investors should review their investment strategies and asset allocation to ensure they have a ‘well diversified’ portfolio. ‘This is especially true if you haven’t been actively rebalancing and have allowed your portfolio to drift over the past few years while interest rates have been so low,’ he said.
Those with savings have been hit hard in recent years by low savings rates but the impending base rate increase is slowly starting to impact the cash savings rates on offer. This comes at a good time for savers who will from 1 July be able to take advantage of the New ISA (NISA) allowance of £15,000 – all of which can be saved in cash.
For those who are keen to see where savings rates are going to go from here it may not be wise to lock into a fixed ISA or fixed rate bond in the short-term.
According to SavingsChampion.co.uk the best variable rate ISAs that allow you to transfer out without penalty of reduced interest is Nationwide’s Flexclusive ISA which is offering 1.75% interest. Higher interest rates are available for those who are prepared to lock their money away for an extended amount of time.
Action to take: the increased ISA limit that will kick in on 1 July is the perfect time to reassess your ISA, the rate you receive and ensure you are putting as much as you can into the tax-free wrapper.
For retirees, savings rate and therefore interest rates are of particular importance. Pensioners may not only be using their savings to top up their retirement income but new retirees may want to hold their pension pot in cash while they wait for more details about the flexibility being offered by changes to drawdown.
‘For those in the immediate run in to retirement, this question of interest rate movements is critical,’ said Tom McPhail, head of the pensions research at Hargreaves Lansdown.
‘Given the current changes to the pension income rules following the Budget announcement, we know that many investors are currently reassessing their options…One simple option for those that need some money from their pension fund now is to go into drawdown, take their tax-free lump sum and park the balance of their money in deposit until next year…they may be able to enjoy a slightly better interest rate as the year progresses.’
Action to take: if you are retiring, don’t do anything! Take advice on what your options are, especially considering the radical changes to drawdown. If you are concern about the next step to take with your pension pot make sure you speak to a professional.
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