Interactive Investor

The only way is up for interest rates

3rd February 2022 12:14

Rebecca O'Connor from interactive investor

The direction of travel is confirmed by the Bank of England.

The Bank of England Monetary Policy Committee agreed by a slim majority of 5 votes to 4 to increase the base rate to 0.5% today and to reduce the amount of quantitative easing.

The Bank is responding to rising inflation, which it expects to reach around 7% in spring.

Becky O’Connor, Head of Pensions and Savings, interactive investor, said: “If there was any doubt, today confirms that the only way is up for interest rates now.

“However inflationary pressures remain for the time being, which means costs look set to continue to rise at a time when borrowing is also becoming more expensive.

“The changing economic picture could require a fundamental rethink among households of how they spend, invest and save their money, after more than a decade of quantitative easing and record low rates.

“Rising rates could tempt people back to saving more and people with money they would prefer to keep in cash rather than investing will be looking keenly to see by how much – if at all - savings rates rise in response.

“They may be disappointed, as base rate rises are not always fully passed on to savers. We also remain some way off a point where keeping money in cash savings begins to look sensible again as a way to preserve the value of money against inflation.

“Savings rates remain in negative territory on a real returns basis, despite rises in the Bank of England base rate.”

Implications of a rate rise on savings for retirees

Becky O’Connor, Head of Pensions and Savings, interactive investor, said: “Increases in interest rates tend to be more beneficial to older people, who are more likely to have more in savings, rather than younger people, who are more likely to be borrowers, for example, with larger mortgages, and less in savings.

“The problem for older, retired people, who understandably tend to prefer the safety of cash later in life, is where to put money instead of cash in the meantime. They have been waiting for years for interest rate decisions to turn in their favour. Now that is happening, but the wait continues for these rises to feed through to the majority of savings rates and for more rises in future to make cash savings rewarding again.

Impact on pensions in drawdown

Becky O’Connor, Head of Pensions and Savings, interactive investor, said: “Some retirees have been forced ‘up the risk curve’ by a low interest rate environment and this isn’t always a comfortable place to be when you are prioritising security of income. Despite these rate rises, it remains difficult to find more secure forms of retirement income that still deliver a good return because inflation is still so high. So for those in drawdown, it remains a difficult balancing act to manage beating inflation without taking too much risk.”

“For those looking to generate as much income as possible from their pension pots, interest rate rises might start to make annuities look attractive again. Rates on these retirement income products have been in the doldrums for years. It will be interesting to see at what point annuity rates, as well as the security of income they offer, starts to tempt people into considering them again, particularly given the current uncertainty in stock markets.”

Impact on workplace and personal pensions

Becky O’Connor, Head of Pensions and Savings, interactive investor, said: “Rising interest rates together with less quantitative easing could dampen investment growth in certain sectors, which may impact returns on people’s workplace and personal pensions.

“If you are paying into a pension and see returns seem slightly lower at the moment, don’t be disheartened. Pensions are very long-term investments and volatility, particularly in times of economic upheaval, is normal.”

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