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Rates on the rise: What’s happening with interest rates?
Despite its name, the interest rate is not something that always attracts a great deal of attention or discussion.
And yet the Bank of England’s decision in August 2022 to raise the interest rate to 1.75% was the trigger for a burst of immediate reaction as well as a long tail of analysis, opinion and conjecture.
Following on from our recent article looking at rising rates of inflation, this article reflects on what’s happening with interest rates and what could happen next.
What is the interest rate?
To state the obvious, there is more than one interest rate, but by far the most significant is the Bank Rate, also known as the Bank of England base rate, which is set by the Bank of England’s Monetary Policy Committee.
This is the rate of interest applied to the cash reserves commercial banks hold with the Bank of England and the benchmark for the rates that commercial banks will offer customers for borrowing or saving – although individual banks are free to set their own rates of interest.
When interest rates are lower, the affordability of borrowing is improved, which can encourage spending and consequently lead to inflated prices. The converse of this situation is also true, meaning the Bank Rate is an important lever for controlling inflation.
Interest rates in recent history
The Bank of England base rate has varied hugely over time. It fell steeply in the wake of the financial crisis of 2007/2008 and remained below 1% for well over a decade. The all-time low was registered on 19 March 2020 when, in the wake of Covid-19, it was cut for the second time in just over a week, falling from 0.25% to just 0.1% as part of emergency measures to counter the financial impact of the pandemic.
This rate is well below the all-time high of 17% registered in 1981 when Margaret Thatcher was Prime Minister, and also the 8% rate of interest that the Bank of England applied to a £1.2 million government loan in its founding year of 1694.
In the context of this history, even today’s low single-digit rates might seem unremarkable. However, the rise in interest rates from 1.25% to 1.75% in August 2022 marked the biggest increase since 1995, and it has sparked subsequent discussion over whether rates should have risen higher and earlier in a bid to tackle escalating inflation.
What happens next?
There are no certainties over if and how interest rates will change in the future. While some economists have advocated a rate cut, many experts predict they will continue to rise in a bid to stem inflation – but there are differing opinions on how far and how quickly.
The National Institute of Economic and Social Research, for example, predicts a rise to 3%, with the potential for further increases dependent on underlying factors driving inflation.
Others have suggested that the Bank of England could push rates up to as much as 4% by the end of this year.
What are the implications?
If interest rates continue to rise, then individuals will face higher borrowing costs. This will manifest itself in the form of higher mortgage rates, for example, although the impact is unlikely to be felt immediately for the many homeowners on fixed rate deals.
The outlook is potentially better for savers if banks reflect any rises in the Bank of England base rate in interest rates for savings and current accounts. And with the pandemic triggering a £180 billion increase in the total savings deposited by Britons, optimising the potential returns from cash reserves may take on greater significance for many.
Crucially, however, it’s important to consider any potential change to interest rates in light of wider economic conditions. Even with improved rates for savings, for example, any returns should be adjusted for the impact of inflation, which continues to erode the real-terms value of wealth.
Against a backdrop of such changing economic factors, it is also important to anchor any decisions to your personal circumstances and ambitions. With clear, long-term goals in place, you are better able to manage your wealth in all its various forms and find balance as economic factors shift around you.
The information contained within this communication does not constitute financial advice and is provided for general information purposes only. No warranty, whether express or implied is given in relation to such information. Vintage Wealth Management or any of its associated representatives shall not be liable for any technical, editorial, typographical or other errors or omissions within the content of this communication.
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