How would higher interest rates affect you?
Governor Mark Carney looks set to announce a rate rise this Thursday, after borrowing figures showed consumer lending still running at around 10%. Although he is only likely to raise rates to 0.5%, the level it was before the shock referendum decision to leave the EU, many believe that the average UK household is not in a position to withstand rate rises.
What is the likely impact for homeowners, savers and investors?
Mortgage rates have started to rise ahead of a rate rise. This is because mortgages rates are priced according to the level of UK government bonds rather than the base rate. UK government bonds will often rise in anticipation of an interest rate rise.
Halifax, the UK’s largest mortgage provider, confirmed rates would go up to 0.2% from 2 October, although some products would see far smaller changes. Skipton also increased rates. That said, it is not universal. Nationwide said this week that it was reducing its fixed rate mortgage deals by up to 0.5% to improve its competitiveness.
However, many homeowners are far less vulnerable than they were to a rate rise. Nationwide chief economist, Robert Gardner, said: “The impact of a small rise in interest rates on UK households is likely to be modest. This is partly because the proportion of borrowers directly impacted will be smaller than in the past. In recent years the vast majority of new mortgages have been extended on fixed interest rates.” Variable rates account for less than 40% of the market today.”
He added, “A 0.25% increase in rates is likely to have a modest impact on most borrowers who are on variable rates. For example, on the average mortgage, an increase of 0.25% would increase monthly payments by £15 to £665 (equivalent to £180 per year).” There are signs that mortgage holders are already taking the decision to fix their rate in expectation of a rate rise.
Theoretically, a rise in base rates should be good news for savers, pushing savings rates higher. However, banks are not always good at passing on rate rises to their customers. Research from independent savings advice site, Savings Champion, found that when the base rate was 0.50%, the average easy access account was paying 0.74%. Today, that average rate has fallen to 0.35% – a drop of 0.39% when the Base Rate has only dropped by 0.25%.
Equally, 0.25% is unlikely to move the dial for many savers. It still means they will have to shop around to get the best rates, and potentially look at higher risk investments to generate an income.
Higher interest rates are usually bad news for government and corporate bonds. It means the coupon on the bond is less valuable and therefore the price goes down. For example, the yield on the 10-year government gilt has moved from below 1% a month ago, to around 1.3%. This is bad for existing investors in gilts, but means that new investors can achieve a higher income. The same is true across much of the bond market.
Moderate interest rate rises are not usually destabilising for stock markets. Although in theory they can raise borrowing costs for companies, in practice, most companies have fixed rate debt. Certainly, the US market has continued to rise higher in spite of rate rises by the Federal Reserve. Also, interest rate rises are usually a sign of an improving economy.
Stocks pay dividends well in excess of savings rates, and with the yield on the FTSE 100 at almost 4%, the income from the stock market still looks attractive even if rates were to raise.
That said, it may affect some companies more than others. Those companies that have been highly prized by investors because they pay a high, reliable dividend, similar to a bond, may not be as sought after if interest rates rise. Therefore, share prices could come under pressure. This might include some of the utilities and consumer staples companies. Investors may want to be more selective in their approach.
And the good news?
The prospect of an interest rate rise is pushing the pound higher. That means anyone who fancies a Christmas break in Europe will have more Euros in their pocket. Every cloud….