What a historic interest rate rise means for personal finances

interactive investor comments on the Bank of England's announcement and the market reaction.

Commenting, Myron Jobson, Senior Personal Finance Analyst, interactive investor, says: “Borrowers are feeling the squeeze from all sides as rampant inflation has stretched budgets, while borrowing costs have risen. The Bank of England has already made borrowing costlier for people in a bid to rein in runaway inflation, and the latest base rate hike, while expected, adds further pressure on crumbling budgets of households with variable rate debt, such as mortgages and credit cards.

“A 0.75% increase in the Bank of England base rate spells bad news for the estimated 2.2 million people on variable rate mortgage deal. They face paying hundreds of pounds extra a year in repayments – depending on the size of their loan.

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“When it comes to fixed-rate mortgages, lenders had already baked in the 0.75% hike in the base rate into their fixed-rate deals. Mortgages rates have hit levels not seen since the financial crisis and with more interest rates rises seemingly around the corner, the burning question is how high will rates on home loans go?

“While anyone on a fixed-term deal is currently protected from rate rises, those approaching the end of their deal are in for a nasty shock when it’s time to remortgage, as the successive rate rises will hit them all at once. This could force many to tear up their existing budget and start again, with the harsh reality of making stark sacrifices to maintain financial resilience as the cost-of-living storm rages on.

Savings

“Enthusiasm for cash savings has been renewed following a reprieve in savings rates. Eight consecutive hikes to the base rate have propped up savings rates from rock-bottom lows. It is a new golden age for savings, but with inflation running at 10.1% and expected to surge higher, the value of cash savings is still shrinking in real terms. But cash savings remain important. The importance of maintaining a rainy-day fund – three months’ salary worth or more if you can afford it – rings true amid the escalating cost-of-living crisis.

“It pays to shop around for the best savings rate, but with the spectre of higher interest rates, savers face a difficult decision of securing a top rate today or holding off for a better deal tomorrow.”

Market comment

Victoria Scholar, Head of Investment, interactive investor says, “The Bank of England has carried out its biggest rate hike since 1989, raising interest rates by 75 basis points to 3%. This is the eighth consecutive interest rate increase lifting rates to the highest level since 2008 at the start of the global financial crisis. The size of the increase signals how concerned Bank of England policymakers are about inflation versus a recession as it looks to curtail further price rises without inadvertently causing unnecessary economic pain. 

“Looking further ahead, the markets are pricing in another 50-basis point increase from the Bank of England in December after which the pace of tightening may slow, depending on the path of inflation. Inflation currently stands at a 40-year high of 10.1% with the Bank of England forecasting it to peak around 11% in October’s data before remaining at around 10% for a few further months. However soaring food prices may push peak inflation beyond 11%. Expectations are for the Bank rate to reach a high of somewhere around 4.75% next summer. 

“An estimated two million borrowers on variable rate mortgages look set to face increased payments after today’s decision, while around another two million are on fixed-term mortgages, which need re-mortgaging, some at higher rates by the end of 2024. The mortgage market has been in turmoil during the aftermath of the mini-budget sending rates soaring and leading to the withdrawal of some products temporarily from the market. However, the market has since calmed down thanks to the new government which has reinstated some sense of political stability.

“The pound has been under pressure this week, coming off the back of a strong month for sterling, regaining ground off the all-time low in September against the US dollar. Cable (GBPUSD) is up by around 7.5% from the trough.

“This week in a historic change of direction, the Bank of England began its shift from quantitative easing (QE) to quantitative tightening (QT) by selling some of its £837 billion accumulation of government debt. The central bank started this unorthodox bond-buying monetary experiment in 2009 in an attempt to alleviate some of the economic pain of the global financial crisis. Nobody expected that 13 years later, the central bank would still be buying bonds.

“However, the post-Covid revival of inflation that was exacerbated by the war in Ukraine has prompted a major shift in monetary policy, with the Bank of England raising rates since last December, and it is now beginning the great unwinding of its legacy stimulus programme as it looks to keep a lid on rising price levels and bring inflation back down towards its 2% target.”