On 22 June 2023, the Bank of England (BoE) raised the base rate to 5%. This 0.5% increase is the 13th consecutive rise, and you may be wondering why interest rates are going up so much, and how this could affect your wealth.
Read on to learn more about why the BoE base rate is rising, if it is likely to fall again, and how it may affect you.
Why is the base rate increasing so much?
The base rate determines the amount of interest commercial banks pay on money they borrow from the BoE. When the base rate changes, other banks typically adjust their interest rates on savings and loans in line with it.
As a result, the BoE can manipulate the interest rates that commercial banks pass on to consumers by changing the base rate. The question is, why are they doing this now?
The simple answer to this is inflation. You have likely seen stories about high inflation and the rising cost of living, and this is largely why the BoE has raised the base rate so many times.
According to the Office for National Statistics (ONS), inflation was 7.9% in the 12 months to June 2023.
Many people consider a low level of inflation to be necessary for economic growth. However, when inflation is this high, it can put financial pressure on consumers as the price of goods and services continues to rise.
That is why the BoE has an inflation target of 2% a year, and why it has been increasing the base rate in hopes of bringing inflation back down to this target.
In theory, increasing the base rate encourages banks to increase their interest rates, which makes borrowing more expensive. It may also make saving more rewarding as you can generate more interest.
As a result, consumers may be more likely to hold onto their cash instead of spending it. This can reduce the demand for goods and services, which slows price rises and results in lower inflation.
Have interest rates been this high before?
A steady increase in the BoE base rate may be concerning as it could affect your wealth.
That said, it is important to note that current interest rates are not especially high when compared with historical rates. They only seem high because we experienced a period of uncharacteristically low interest rates since 2008, as you can see from the graph below:
As you can see, interest rates were above the May 2023 level back in 2007. But after the 2008 financial crisis, interest rates plummeted to support the economy by reducing borrowing costs and encouraging investment.
The rates in 2007 were not abnormally high either. Indeed, according to the BoE, the base rate reached 17% on 15 November 1979, and was often above 10% until rates started falling in the 1990s.
Theoretically, there is no reason why interest rates cannot reach this level again, or even exceed it. Whether that will happen or not depends on several factors.
Will interest rates keep rising?
It is difficult to accurately predict whether interest rates will rise or fall because nobody can see the future.
Global events like the war in Ukraine or the lasting effects of the pandemic, which have caused the price of certain goods and services to rise, are a big contributor to inflation. And if inflation continues to exceed the BoE target, then interest rates will likely go up too.
While the BoE expects to reach its inflation target eventually, this may take some time. In its May 2023 Monetary Policy Report, for example, the BoE predicted that inflation would fall to 2% by late 2024.
Unfortunately, there may be more interest rate rises in the coming months to help reach this target. Predictions from JP Morgan, as reported by the Independent, suggest that the base rate could reach as high as 7% before inflation starts falling again.
Similarly, in June 2023, Schroders predicted that interest rates could reach 6.5% by the end of the year. Their May forecast was 1.5% lower than this, but they increased it because they do not believe that the BoE has inflation under control yet.
These are only predictions and there are no guarantees about the future. That said, the base rate could well continue to rise for the rest of 2023 and beyond, and you may need to consider how this affects your wealth.
Mortgage rates hit their highest level since 2008
According to the Guardian, the average two-year fixed mortgage rate in the UK rose to 6.66% in July – the highest level since the 2008 financial crisis.
As the BoE base rate increases, lenders are increasing their interest rates too. This could mean that your mortgage payments go up in the near future, if they have not already.
If you are on a fixed-rate mortgage that is soon coming to an end, your lender will likely move you onto their standard variable rate (SVR). Typically, this interest rate is determined by several factors, including the BoE base rate.
As such, it is likely to be much higher than your current fixed rate.
Similarly, a tracker mortgage usually follows the base rate. While this can be beneficial when interest rates are low, your payments have likely been rising for more than a year now if you have a tracker mortgage.
The best 5-year fixed Cash ISA interest rate is 5.26%
Ordinarily, a high base rate is good news for savers as it means they may generate more interest on cash savings.
However, while savings interest rates are beginning to climb, they are not increasing as fast as consumers hoped they would when the base rate went up.
Chancellor of the Exchequer, Jeremy Hunt, has been critical of low interest rates and put pressure on banks to increase rates faster. However, it remains to be seen whether they will take action and current rates are still significantly lower than inflation.
According to MoneySavingExpert, the best five-year fixed Cash ISA interest rate is 5.26% in July 2023.
Unfortunately, with inflation at 7.9%, your savings may lose value in real terms because the price of goods and services is growing faster than the cash in your savings account.
So, even though savings account interest rates are starting to catch up, you may not see real-term growth until inflation comes down again. Here’s a useful explainer on how inflation affects your cash savings.
Get in touch
If you are concerned about how rising interest rates could affect your wealth and you want to learn more, we are here to help.
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This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
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