Will interest rates rise to 6%?

Myron Jobson explains what the fall in the value of the pound and the prospect of interest rates rising to 6% means for personal finances.

Commenting, Myron Jobson, Senior Personal Finance Analyst, interactive investor, says: “The fall in the value of the pound means it now costs £205 more to buy $1,000 than it did this time last year (£935 versus £730) and £46 more to buy €1,000 (£901 versus £855).

“A weak pound means it will be more expensive for UK businesses to imports goods and services denominated in dollars. Some companies with strong brands and deep pockets might be able to absorb the heightened cost burden. But with rampant inflation, soaring energy bills and a tight labour market fuelling wage growth already weighing on revenues, many will have no choice but to pass on costs to consumers.

“This risks pushing inflation up even further and could result in more aggressive interest rates hikes in a bid to curb rising prices. However, the impact of this could be more limited as the items most effected by rising prices are everyday essentials – meaning that consumers have little choice but to pay more.

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Mortgages

“Rises in interest rates to 6% would result in an eye-watering uptick in mortgage rates to levels we haven’t seen in a while. The 2.2 million homeowners with variable rate mortgages will automatically feel the brunt of the uplift in the base rate, while those approaching the end of their fixed term deals will be in for a serious shock when they seek to refinance.

“The growing affordability burden could have a cooling effect on the sizzling housing market – although the ongoing demand-supply mismatch could may well continue to prop up house prices. Even with the cut to stamp duty, things don’t seem to be getting easier for first time buyers. Many will be forced to put their dreams of home ownership on hold until the cost-of-living storm passes.

“Anyone looking to buy or remortgage in the near future should consider securing a deal now. Mortgage deals are often valid for a number of months, and it is not too early to start looking for the best deals now.”

Loans and credit cards

“For those pre-existing debt arrangements such as a personal loan or car financing, an interest rate hike won’t usually be affected by changes to interest rates.  However, the rate of interest applied to credit cards and overdrafts could go up - even though they are not directly linked to the BoE base rate.

Savings

“On the flip side, higher rates mean savings will earn more – although some banks and building societies may still be catching up to past base rate rises. However, runaway inflation remains higher erodes the purchasing power of cash savings over time – but it still pays to pick the most competitive account.

“It is interesting to note that the BoE’s recent survey on the public’s attitudes to inflation found that that almost a third of respondents said it would be better for them if interest rates were to ‘go up’, but a quarter of the sample said the opposite, indicating that cost of living experiences are polarised.

“Many households will want to try taking steps to shore up their finances: pay down debt starting with the costliest ones and variable rate loans; and build and maintain an ample cash buffer for emergency spending – three months’ salary worth is a good rule of thumb, if not more. Both will allow households to better weather higher interest rates and the cost-of-living crunch which is set to become more acute.”