Interactive Investor

Bank of England holds rates at 5.25% after inflation surprise

As interest rates are held for the first time since November 2021, Craig Rickman examines how this might affect your mortgage and savings.

21st September 2023 13:58

by Craig Rickman from interactive investor

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After 21 months and 15 policy meetings, the Bank of England (BoE) has finally hit the pause button on the most aggressive rate hiking cycle in modern history.

The BoE’s Monetary Policy Committee voted by a majority 5-4 in favour of keeping interest rates at 5.25%, after inflation defied expectations to nudge down last month.

Yesterday it was confirmed that the Consumer Prices Index, the UK’s main measure of inflation, surprisingly fell from 6.8% to 6.7% in August, putting today’s policy decision on a knife edge.

In response to this data, odds of a 15th consecutive rate hike were slashed from 80% to less than 50%, with many economists urging the UK central bank to maintain rates at their current levels.

Across the Atlantic, the US Federal Reserve (Fed) also kept rates on hold, despite inflation accelerating to 3.7% in August due to soaring oil prices which has fed through to the pumps. But its rate target of 5.25%-5.5% is still higher than at any point in the past two decades. And the Fed hinted it might hike rates again later this year.

Both the BoE and the Fed face the delicate balancing act of bringing inflation down without plunging their respective economies into sharp downturns. The UK economy shrank 0.5% in July, thanks to combination of wet weather and industrial strikes, which has increased the risk of a recession.

Now that UK interest rates appear to have peaked, the next question to ask is when they will start to fall. But with inflation still well above the BoE’s 2% inflation target, we can expect the base rate to remain elevated for some time.

As always, the BoE’s interest rate decision will impact your finances in some shape or form. Let’s look at what it might mean for you.

What does this mean for your mortgage?

Borrowers can breathe a sigh of relief that rate hikes have finally ground to a halt – especially those with tracker mortgages whose monthly payments will remain unchanged after today’s announcement. Many homeowners have seen repayments skyrocket due to the base rate rising from 0.1% to 5.25% since December 2021.

Despite the trajectory of interest rates, mortgage rates have edged down recently with lenders engaging in price wars, providing some green shoots to anyone looking to buy their first home or remortgaging. And we might see further falls now that interest rates have been kept on hold.

However, the mortgage deals currently on offer are still far higher than they were a couple of years ago. Rachel Springall from Moneyfacts, said last week that the average two-year fix in September 2021 was just 2.38%. But according to Rightmove, the average five-year fixed mortgage rate has jumped from 4.32% to 5.63% over the past year, while the average two-year fix is now 6.16%, up from 4.44% in September 2022.

As Myron Jobson, interactive investor’s senior personal finance analyst, noted: “Mortgage holders with a fixed-rate deal continue to be shielded from the recent movement in interest rates. However, it's important to keep an eye on the horizon, as once that shelter expires, they’ll likely contend with higher rates when refinancing their mortgage.”

The big decision borrowers face is whether to secure a fixed or variable rate deal. There are pros and cons to each. If budgeting is important to you then consider a fixed deal, but if you believe that interest rates might fall during the mortgage term you select, then a variable rate mortgage could work out cheaper.

If you need some help finding the right deal for you, then consider paying for some expert advice.

What’s happening with savings rates?

Savings rates should stabilise after today’s decision but have improved dramatically in the past 18 months. The best easy access savings accounts now pay north of 5% a year, while several providers are offering more than 6% if you’re prepared to lock the away for 12 months. It’s wise to tread a bit carefully with the latter though. That’s because if you need to access the money during the term you could lose some or all your interest.

If your current bank or building society is paying below par interest on your savings, switching your money elsewhere could put hundreds of extra pounds in your pocket.

How to put your money in the right home

Before you make any decisions with your savings and investments, it’s wise to take a step back and think about the role you would like this money to play in your future. This will get it working in the way that’s right for you.

So, what are the things you need to consider when saving and investing for your future?

The first port of call is to make sure you have at least six months’ expenditure in an easy-access account that can cover any emergencies should they arise. This money needs to be accessible, flexible, and capital secure.

It’s typically best to avoid tying this money up in a one-or-two-year fixed term bond as you could forfeit valuable interest payments should you need to access the cash.

You should also swerve the stock market here because if share prices crash when you need the money it may not cover six-months’ expenses. A Cash ISA can be a good option with your rainy-day fund, unless your plan to use your full £20,000 allowance to invest in the Stocks and Shares version.

Otherwise, look for the easy-access savings accounts paying the highest rates of interest.

For any other savings you hold, you will want to make sure your money works as hard for you as possible, which has never been more important with inflation still high. If your savings don’t keep up with rising prices, the buying power of this money will reduce over time.

Divvying up your savings goals into buckets can be an effective and simple approach.

For each bucket designate a timeframe. For example, one bucket for emergencies, another for any big-ticket purchases – such as holidays or a car - within the next 1-5 years, and then a final bucket for your long-term future.

Bucket one might contain your rainy-day fund, bucket two some fixed-term bonds, with stocks and shares making up bucket three, providing you’re comfortable with the ups and downs that come with investing in the stock market.

As always, focus on keeping your savings and investments as tax efficient as possible, making use of tax wrappers such as individual savings accounts (ISA) and your annual savings allowance where you can. This allowance means you can earn up to £1,000 a year in interest without paying tax. If you pay 40% tax, your allowance reduces to £500, and if you are an additional-rate taxpayer you don’t get an allowance. All interest you earn outside of tax wrappers is taxable.

You should also consider drip-feeding any leftover income into these buckets, again based on your timeframe and how much access you need. But whatever you do, don’t forget your pension as this could shave some money off your tax bill and give your retirement savings a shot in the arm.

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

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