In June, the Bank of England (BoE) increased its interest rate for the fifth time in six months. It now stands at 1.25%, the highest it’s been in 13 years, the BBC reports.
The key reason for the increase was identified by the BoE’s Monetary Policy Committee (MPC), which sets the Bank’s interest rate. It predicts that inflation could reach 11% by the end of 2022, adding that it would be prepared to “act forcefully” should inflation continue to skyrocket.
Because of this, some economists are speculating that the bank’s interest rates could reach 3%. While rising interest rates may mean better deals being offered for savings accounts, it could have other implications for your finances.
Discover what they are, why the value of your savings might reduce in real terms despite the increases, and clever steps you could take to help inflation-proof your wealth. Before you do, we need to look at why interest rates typically rise when inflation does.
Interest rates help to control inflation
Inflation is the rising cost of goods and services, which means that you have to pay more over time to maintain your same standard of living. If your cash is not keeping pace with inflation, it could lose value in real terms as its spending power reduces.
While a small amount of inflation is generally regarded as a good thing for a healthy economy, when it becomes too high it can stifle economic growth as the cost of raw materials, goods and services soar. This is why the Bank of England (BoE) aims to keep it at 2%.
Historically, when inflation starts to rise too much, interest rates are increased as it helps deal with one of the main drivers of inflation: consumer demand. This is because it encourages people to save their money instead of spending it on goods.
This brings us to the first of three possible implications that rising interest rates could have for your money.
1. The amount you earn from your savings could increase
While high street banks do not have to increase the rate of interest they pay to savers when the BoE increases its rates, they often do to attract savers.
While this may sound good, inews reveals that an increase of 0.25% in interest rates would only boost the interest you earn by an additional £50 a year if you had £20,000 in savings.
Furthermore, even with the BoE’s increase, interest rates for savings are likely to remain significantly below the rate of inflation, which the Office for National Statistics revealed was 9.1% in May 2022.
According to Moneyfacts, as of 7 July 2022, the top easy access savings account offered 1.4% interest, with the top five year fixed-rate offering 3.3%. It adds that the top instant access Cash ISA offers 1.3%, with the best five year fixed-rate Cash ISA offering 2.6%.
As you can see, all of these figures are significantly lower than May’s inflation rate, meaning your money is not keeping pace with the rising cost of living and, as such, is losing value in real terms.
2. The cost of loans could increase
Another way interest rates control consumer spending is to increase the cost of borrowing, which might mean that people put off buying big-ticket items.
While savers have struggled to generate inflation-busting returns in recent years, borrowers have benefited from exceptionally low rates. This could now change, as the BoE’s interest rates are typically used by high street banks and other lenders to set their lending rates, which includes mortgages.
As the BoE’s interest rate has risen, it’s likely that repayments for some mortgages, including tracker or standard variable rate (SVR) mortgages, will do the same.
According to the Guardian, if you had a tracker mortgage at 2.25%, the rate increasing to 2.5% would mean your monthly repayments would go up by £18 a month if you have a £150,000 mortgage over 20 years.
There is good news though. If you currently have a fixed-rate mortgage, it’s unlikely to be affected until your agreed period runs out. When it does, your rate will probably revert to the lender’s SVR.
3. The stock market could become more volatile
It’s difficult to know how increased interest rates could affect investments, although it’s likely to mean increased volatility in the stock market. This is because some investors may decide to switch to cash, in the belief that it’s a lower risk way of gaining potentially higher returns.
Additionally, higher rates could mean increased repayments on debt for companies and decreased consumer demand, which could reduce profits. This in turn could result in businesses’ share value dropping, something that could further contribute to uncertainty in the stock market.
That said, if an increase in interest rates causes a downturn in the markets, it’s likely to be short term. This means that investing for the long term could still be a more effective way to potentially inflation-proof your cash.
This is backed up by research by Schroders, which revealed that between the start of 1952 and the end of May 2022, UK equities returned 11.7% a year on average. According to the global investment manager, cash returned 6% a year.
While there were plenty of short-term downturns for UK stocks and shares during the 70-year period, some of which were significant, stocks still outperformed cash over the long term.
Always remember though, the value of your investment can go down as well as up, and you may not get back the full amount you invested.
Past performance is not a reliable indicator of future performance.
Get in touch
If you would like to discuss the implications of rising interest rates on your finances, and effective ways to potentially inflation-proof your money, please email us on admin@stonegatewealth.co.uk or call 01785 876222.
Please note
This article is for information only. Please do not take action that is based on anything you read in this article until you have sought professional advice.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
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