Interest rate hike: what does it mean for your savings, mortgage and investments?

With a recession looming and a record-breaking interest rate increase, Alice Guy looks at what the 0.5% rate rise means for your finances.

As expected, today the Bank of England raised interest rates by a historic 0.5%, following the Federal Reserve’s recent 0.75% hike. The base rate increased from 1.25% to 1.75% in an attempt to control galloping inflation. The Bank of England commented that, “the Monetary Policy Committee (MPC)’s remit is clear that the inflation target applies at all times, reflecting the primacy of price stability in the UK monetary policy framework.” 

It’s a bleak picture as the Bank of England also released figures that predict a long recession by the end of the year.

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The latest rates rise will do little to ease the worries of private savers and investors as they aim to beat rising inflation and protect investments from stock market volatility.

Mortgage rates

For the unlucky 20% of us on standard or variable mortgage deals, the interest rate rise will be a painful shock to family finances. Someone with a £200,000 mortgage will pay an extra £83 per month and £996 extra per year and £275 more per month than they paid last Christmas when the base rate was 0.1%.

Thankfully, most homeowners (80%) are on fixed interest deals and will be protected from interest rate rises in the short term. But they will need to budget for rate rises once their deal ends in due course.

Rachel Springall from Moneyfacts commented that, “borrowers who have not locked into a fixed rate would be wise to move quickly to secure a new deal as interest rates continue to climb. Fixing for longer may be in the mindset of some, as there is anticipation for further base rate rises to come. Consumers will find that the average five-year fixed rate has breached 4%, and the rate gap between this and the average 10-year fixed rate has closed in since December 2021.”

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Saving rates lag behind interest rate rise

For savers, the rate rises are good news, but they’re not home and dry yet as banks have a nasty habit of delaying passing rate rises on to customers. Recent research from Moneyfacts showed that only 51% of easy access savings accounts are currently beating the Bank of England base rate compared with 79% in December 2021.

Rachel Springall, finance expert at Moneyfacts, commented that, “the market clearly has more room for growth but, as we have seen in the past, a base rate rise does not always get passed on to consumers. However, it should encourage savers to compare deals and switch.”

Springall continued that, “keeping abreast of the top rate tables is essential and there is little reason for savers to overlook the more unfamiliar brands if they have the same protections in place as a big high street bank. Easy access accounts remain popular, but savers must be sure to check the terms and conditions as not every deal will give them complete flexibility. In times of uncertainty, it’s wise to have quick access to funds to fall back on to cover unexpected costs.”

Medium-term savers could instead consider money market funds or bonds as an alternative to savings accounts. Historic data shows that when interest rates return to more normal levels, money market funds tend to outperform cash savings accounts.

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Impact on investments

Higher interest rates generally mean lower equity prices because they lead to higher borrowing costs for businesses and individuals. Conversely, low interest rates can result in surging equity prices, as we saw in 2021 when interest rates were 0.1%.

However, the impact of the latest rate rise on equity prices is likely to be limited as it was in line with expectations and there are signs that the market is already looking further ahead. Equity prices actually rose in July, partly in response to expected interest rate cuts on the longer-term horizon. In the medium term, a recession is looming, and interest rate cuts could be on the cards in the future.

Dzmitry Lipski, head of funds research at interactive investor, said that “inflation continued to rise, and the economy is slowing down, so the focus is shifting to the possibility of the Fed cutting rates next year. On balance, this should be positive for risk assets, therefore we saw some recovery in equities recently with growth stocks performing well”.

Given the current economic uncertainty, a balanced investment approach is sensible, and investors should make sure their investments are well diversified.

Lipski commented that, “given the recent market sell-off, bonds valuations are looking relatively attractive, offering attractive total return potential with less downside risk.

“Bonds should continue to offer investors the benefits of diversification away from equities, along with stable income and relatively low volatility especially in periods of economic uncertainty, lower growth and even recession.”

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