UK interest rate raised to 4.25%

25bps rise was already baked in, but inflation upturn and banking sector turmoil flip the script.

Commenting, Myron Jobson, Senior Personal Finance Analyst, interactive investor, says: “The 25bps hike was already baked into the money market, but the surprise upturn in inflation last month and the turmoil in the banking sector has flipped the economic script.

“The Bank faces a difficult task in balancing two conflicting problems that could weigh on the economy: the risk of stubbornly high inflation and the threat that banks may tighten their lending criteria, which could have the potential to choke growth for individuals and businesses. As such, the outlook for interest rates isn’t clear cut – meaning that mortgage holders, savers and borrowers will need to keep on their toes. The consensus is that there’s one more increase to go, with the peak rate being focused at 4.5%, but that will be very much data dependent and could all too easily change.”

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Mortgages

Myron Jobson says “When interest rates rise, the estimated 1.6 million people on tracker and variable rate deals usually experience an immediate uptick in their monthly payments. This is on top of recent rate rises, compounding the financial pressure on household budgets at a time many can least afford it.

“Those on fixed-rate deals are shielded from initial increases in interest rates, but they won't remain unaffected forever. Those nearing the end of their fixed-rate deal could be in for a nasty shock when they remortgage. ONS data shows the number of fixed-rate mortgage deals coming to an end in 2023 will peak in the next quarter of this year at 371,000.

“Those approaching the end of their mortgage deal could benefit from being proactive in seeking the best deals now to have more options on the table further down the line. All mortgage offers are valid for a fixed amount of time. Typically, they will last between three and six months, depending on the lender. You are not tied to mortgage contracts until you sign on the dotted lines, so you can ditch it if you find a better deal in the interim.”

Alice Guy, Head of Pensions & Savings, interactive investor, says: “It’s a confusing time for mortgage holders and savers. Interest rates are still rising but rates on fixed mortgages have actually gone down since the autumn. They may be wondering what’s going on and if it makes sense to fix their mortgage or wait for rates to drop back.

“The reason fixed-rate mortgage rates have dropped slightly is because lenders set interest rates depending on their expectations for interest rates in the future. Despite interest rates rising, they are rising less than original feared by lenders last year.

“The harsh reality for many of us on fixed-rate mortgages is that the pain of higher interest rates is only just beginning. We’re unlikely to see interest rates coming down any time soon and that means most of us will be forced to fix at a higher rate once our current mortgage deal comes to an end. As always, it’s definitely worth shopping around as some mortgage interest rates are much cheaper than others.

“If you’ve had a decent pay rise, the one silver lining is that your mortgage costs should come down over time as inflation erodes the value of your payments. Lenders work out mortgage payments over your whole term, which means you’ll pay the same amount in 20 years as this year, depending on interest rates.”

Bank savings

Myron Jobson says: “Higher interest rates do not always translate to higher savings rates. It could take months for the increase in interest rates to trickle through to savers – if at all. The acceleration in the frequency of rate rises has meant that some savings providers may still be catching up to past base rate rises.

“With the OBR forecasting inflation to drop below 3% by the end of the year, there is a sense that the savings rate increase cycle is nearing its end. But there is still plenty of uncertainty, and inflation could remain stubbornly higher for longer. While you might get a better rate in the near future, there are no guarantees – and an uptick in savings rates could mean the difference between pennies and hundreds of pounds depending on how much you have to save.”

Borrowing

Myron Jobson says: “Common borrowing arrangements such as a personal loan or car financing won’t usually be affected by changes to interest rates because a fixed rate of interest is typically agreed before the loan is taken out. 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.

“Those with high levels of debt should consider what they can do now to reduce their debts as the cost of credit is rising just as the prices of everyday essentials are flying. It is worth consulting a debt advice charity such as StepChange or Turn2Us and they will go through all your options.”