Interest rate rises

Mark Carney might finally be able to shake the moniker of the ‘unreliable boyfriend’, following the Bank of England’s announcement to increase interest rates from 0.25% to 0.5%.

Seven of the nine members who make up the Bank of England’s Monetary Policy Committee voted in favour of raising rates by a quarter of a percentage point.

The move in the base rate from 0.25% to 0.5% marks the first rate hike in more than a decade and the first since the dark days of the financial crisis. It’s significant but shouldn’t come as a big surprise to the market with the Bank of England signalling to markets ever since August that they should expect an interest rate hike.

A strong body of opinion in the central bank, which includes the governor Mark Carney, believe that the UK economy is becoming more vulnerable to inflation, meaning even a small improvement in the Bank’s growth forecast would require higher interest rates to stave off rising prices.

The bigger question however is whether today’s increase is largely symbolic, taking rates back to the ‘emergency’ level of 0.5% prior to last year’s shock Brexit vote, or whether this spells the beginning of more rises to come? Most importantly, what does last week’s rate rise mean for consumers?

Here’s a run-down:

Savers: The UK has more savers than borrowers, and those who have been prudent with their money will finally have something to cheer about after having to contend with rock-bottom rates for more than ten years. But with inflation hitting a five-year high of 3%, cash savings which offer a return that beats rising prices, remain scarcer than hen’s teeth. Unless you’re willing to lock up your money for a substantial amount of time, the stock market continues to be your best bet for a real return. Evidence of this is the latest Capita Dividend Monitor which reported a bumper third quarter dividend crop for those investors who have been brave enough to turn to the stock market in their search for income. According to the report, the top 100 companies in the UK offer a prospective yield a touch over 3.8%, while the FTSE All Share’s collective yield stands at 3.7% (and that’s not counting any special dividends that may be paid in the future).

Meanwhile, the income on 10-year UK gilts over the third quarter stood at 1.4%, while instant access savings were unchanged at 1.3%. Despite the rate rise, equities will remain comfortably the most attractive of the main asset classes for income, as they have for several years now.

Retirees: Many retirees are risk averse and tend to favour cash so better returns on cash deposits will be warmly welcomed by retirees. Annuity rates which have been at historical lows could improve with a rise in interest rates, which means those planning on buying an annuity could secure a higher income.
Less positive is the possibility that retirees could see a fall in the value of their pension funds. This is because when investors near retirement age, pensions savings are often automatically moved out of the market and into bonds, as a way of de-risking pension savings – a process known as ‘life-styling’. Bond prices tend to fall when interest rates rise, in order to increase the yield and attract buyers.

Borrowers and mortgage holders: Today’s announcement spells bad news for all borrowers. Many haven’t seen debt costs rise since July 2007. There are already growing concerns about a UK household debt crisis and today’s rate hike won’t help matters putting increased pressure on Britain’s cash-strapped households who will have more to pay back each month. Those with variable rate mortgages will be among the biggest losers of a rate rise as they will see their mortgage payments go up, putting further pressure on their household finances, which are currently being squeezed by a deadly combination of high inflation and stagnant wage growth. While the majority (57%) of borrowers are on fixed-rate deals and so won’t be affected by the base rate hikes as long as their fixed rate lasts, according to the Bank of England, the remaining 43% of homeowners on variable or tracker rates will see a hike. And, probably before Christmas. According to figures from the Nationwide Building Society, on an average mortgage of £125,000 a 0.25% rate rise would push monthly payments up by £15 to £665. That’s an additional £185 a year.
We could see some mortgage borrowers rushing to fix, as lenders withdraw their best deals. But remember that it can take several weeks, even months, for any new mortgage deal to be processed.

Investors: While rising interest rates are likely to hurt those on variable rate mortgages, it could spell good news for investors that are exposed to cyclical sectors of the economy, in particular financial stocks. Banks have long suffered from the historically low rate - which has not risen since 5 July 2007, however rates going up gives banks greater potential to make money on the difference between the rates on the loans they make and the interest they pay on deposits. 

Millennials: Those trying to get a foot on the housing ladder, such as millennials, will find that the first rung has just got a little harder to reach as the cost of getting a mortgage goes up.
In 2014 new mortgage rules tightened up what you could borrow. Anyone who’s applied for a mortgage recently will know that lenders base their decisions on what borrowers can afford after all their other costs - whereas before it was a far more crude calculation based on your income. What that means is that any rise in mortgage rates automatically lowers the amount you can borrow. Using Google’s online mortgage calculator, here’s a rough example: Someone who can afford to repay £1,000 on a mortgage, with a mortgage rate of 2%, could borrow about £236,000. If the rate rises by just a quarter point - the amount they can borrow falls to about £229,000.

The pound and UK property: Today’s announcement will give the pound a short term boost but the interest rate rise to half a per cent is largely symbolic. More importantly, is what Mark Carney says alongside the rate rise - his so-called ‘forward guidance’ - something he has not always got right. The worry is that the first rate rise in more than 10 years could have an big impact on the mindset of consumers, who are already worried about rising prices, stagnant wages and the long shadow cast by Brexit.

A burning question is whether the UK’s property market goes into temporary hibernation. Housing market trends really depend on developments in the wider economy and given the squeeze on UK households’ spending power, many may be reluctant to commit to a major financial transaction such as buying a house. Rising interest rates adds to this cocktail of worries.

Ultimately, it’s the psychological impact of the first rate rise since 5 July 2007 that will be the most important, and here the UK’s property market is arguably most exposed.