Laura Suter, head of personal finance at AJ Bell, comments on the Bank of England’s decision to raise rates to 0.5%:
“Clearly trying to redeem his title as an unreliable boyfriend, Andrew Bailey and the rest of the Monetary Policy Committee have voted by a whisker to increase interest rates to 0.5%. The vote was narrow at 5-4, but rather than voting against any increase, the dissenting four members wanted to jack rates straight up to 0.75%. The raise marks the first time since 2004 that the bank has raised interest rates in two consecutive meetings.
“For once the market and the Bank appear to be aligned, with the market expecting a rise to 0.5% today and an increase to 1.25% by year end. The Bank has confirmed it’s on track to raise rates to 1.5% by the middle of next year, sending out a large signal to the nation that it’s not just going to stop after two increases.
“The bigger surprise buried in the accompanying inflation report is that inflation is now expected to peak at 7.25% in April – leaving the Bank of England’s target of 2% a distant memory. This rate rise comes hot on the heels of Ofgem’s energy price cap announcement, and the Bank is firmly pointing the finger at energy costs for that spike in inflation. Once again commentators will be pondering the impact that interest rate rises will have on limiting inflation, when the biggest contributor is wholesale energy prices – which couldn’t give a hoot about the UK’s Base Rate.”
What does the rate rise mean for…
Homeowners:
“Anyone on a variable rate mortgage will see their interest rates go up – mortgage companies are very quick to pass on the Base Rate hike. The Base Rate rise to 0.5% will mean someone with a £250,000 variable rate mortgage* will pay an extra £384 a year. With higher borrowing of £450,000 the increase in costs is more dramatic, at an extra £684 a year.
“The Bank projects that base rate will rise to 1.5% by mid-2023. If this is the case, homeowners with £250,000 of borrowing will have to pay an extra £1,956 a year, compared to the start of the year, while those with £450,000 of borrowing will have to find an extra £3,528 a year, or £294 a month.
“One option is to fix your mortgage now, so you lock in current rates and avoid any future interest rate rises. Mortgage companies have already started to increase their rates, and they’ll rise again now the rate rise has actually happened. Someone with £250,000 of borrowing on the average standard variable rate mortgage now*** could save £5,316 a year by switching to the current top two-year fix. If someone wanted to switch for longer they’d save less each year, but more over the term of the fix.”
*Assumes a repayment mortgage with a 25-year term, at the current average variable rate of 2.47%, based on BoE figures.
** Assumes a repayment mortgage with a 25-year term, at the current average variable rate of 2.47%, based on BoE figures. Switching to the top two-year fix of 0.99% from Natwest, on 80% loan-to-value. Rate was still available at time of release.
***Based on Moneyfacts.co.uk data of 4.46%
Savers:
“While banks are very quick to pass on any Base Rate increases to their mortgage customers, savers will have to wait longer and many won’t see any increase at all. Lots of people’s savings are just sitting in their current account or their old savings account, where the rate is likely 0.01%. And these people likely won’t see an increase in the interest rate they’re being paid, instead banks will pocket the difference to boost their profits.
“But that doesn’t mean savers need to miss out, they just need to do a little more work to get a higher rate. After a rate rise we usually see rates edge up and more competition in the best buy tables as providers vie to reach the top, but you’ll have to switch to get a better deal.
“Anyone thinking of fixing their savings rate needs to consider the bank’s plans to increase rates further from here, as if you lock in a rate now you’ll miss out on any future Base Rate rises. The top two-year fixed rate account is currently paying 1.62%***, which is significantly more than the top easy-access account of 0.71%. But both those rates could rise now Base Rate has increased – and if you’ve already locked in for two years you’ll miss out on any rise.
“If you have £10,000 saved and put it in the top two-year fix now you’d have made £327 interest at the end of the two years, but if you wait and savings rates rise by the same 0.25 percentage points as Base Rate, you’d make an extra £51 in interest. If Base Rate rises to 1.25% and all that gets passed on to savings rates you’d make an extra £204 in interest at the end of the two years.
“Inflation has soared in recent months and is expected to hit more than 7% in April. This means that even with interest rates rising, if savings rates rise by the same amount as Base Rate you’ll still be nowhere near beating inflation. The current top easy-access savings account pays 0.71% interest, even if all of the Base Rate rise to 0.5% gets passed on to savers then the top account will pay 0.96%. That’s still miles away from current inflation of 5.4% -- and even further from that 7% figure. At those rates and current inflation if you had £10,000 invested, after a year your money would be worth £444 less in real terms.
“Cash is a great place for short-term savings or money you need quick access to, but it’s not ideal for long-term savings. So, work out what you need in the next five years or as an emergency pot, and see how that stacks up against the amount you’ve got in cash. If you’ve got way more than that set aside, think about investing it.”
Those in debt:
“Anyone with debt is going to really feel the pinch of this interest rate rise, as the cost of borrowing on credit cards, personal loans or store cards could rise. Banks are very quick to pass on any rate rise to customers when it benefits them, so those with debt should be braced for higher costs.
“The cost of debt has already risen in anticipation of a rate rise, with average overdrafts interest rates being just under 21% - a record high*, while personal loan interest rates also rose in November to 6.43% -- the highest since pre-pandemic times.
“Anyone with debt needs to work out if they can switch it to cheaper borrowing, and get in quick before rates do rise. Look at whether you can transfer credit card borrowing to a 0% balance transfer deal or see if you’re eligible for an interest-free overdraft. After that, people should list out their debt from the most expensive to the cheapest, regardless of the amount owed on each one, and prioritise paying off the most expensive before moving down the list.”
* based on Bank of England data: https://www.bankofengland.co.uk/statistics/money-and-credit/2021/november-2021
