Whether you are a saver, an investor or someone with a large mortgage (or all three), your finances will be affected by the direction of the Bank of England base rate this year. Where the Bank leads, other financial institutions follow, so those with mortgages will end up paying more for their borrowing, while those with savings may earn more in interest if they are sensible enough to search out the highest-paying accounts.
Those with investments will be affected by interest rates too, as the businesses that we invest in will be affected by the rate at which they borrow money.
So, what are rates predicted to do in 2023, and how will it affect your money?
The current situation
At present, Bank of England base rate is at 3.5 per cent, which is its highest level in 14 years1. This time last year they were just 0.25 per cent, having risen from lows of 0.1 per cent during the crisis phase of the Covid19 pandemic2.
The Bank has raised rates in an attempt to deal with rising inflation – in theory higher rates dampen demand and put a lid on rising prices – and experts believe that they will have to rise further to help to tame the Cost-of-living crisis.
The existing rises have already influenced the cost of borrowing and savings rates. In December 2021, according to Moneyfacts, the average mortgage rate was 2.34 per cent for a two-year fixed rate mortgage3. By December 2022, it was 5.8 per cent. Someone paying a £100,000 25-year mortgage at those rates would now be paying £200 more every month than the £440.60 they were paying last December.
Those with savings are luckier, though the difference is not so stark. Rates in December for easy-access savings were 1.53 per cent on average, compared with 0.19 per cent a year ago4.
Someone with £10000 of savings would receive £12.50 a month in interest in a 1.53 per cent account and just under £1.70 a month from a 0.19 per cent account.
What happens next?
Increases to the Bank Rate in 2022 were swift and frequent, but there are signs that the pace may be gentler this year.
The Monetary Policy Committee was split on its rate increase in December, with six members voting for the 0.5 percentage point increase, two voting for rates to stay the same and one voting for a 0.75 per cent increase. The committee said there were “considerable uncertainties” around the economic outlook and that it will “respond forcefully” if necessary if inflation remains persistent5.
However, the split may indicate that there will be fewer rate rises than previously expected on the horizon.
In November, the market was pricing in a peak in rates of 4.75 per cent in summer, but some economists believe it will be much lower, with HSBC forecasting 3.75 per cent, and Nomura 4.5 per cent6.
What actually happens will depend on how the UK economy performs in the coming year, with most predicting a tough year with continuing high inflation.
In 2024 and 2025, the Office for Budgetary Responsibility – the government’s economic forecaster – expects things to improve after a long recession7.
What should you do about this?
Borrowers
The biggest problem with rising rates comes for those with mortgages, particularly if they are coming to the end of fixed-rate deals.
More than 800,000 households will see their mortgage rates triple this year, according to the Office for National Statistics8. If you are among them, it makes sense to see a mortgage broker as soon as possible to see what your options are.
Making overpayments (if you can) could reduce your loan-to-value, putting you in line for cheaper deals, while a broker will be able to talk you through the pros and cons of longer and shorter fixes, and the possibility of extending a mortgage term if new payments are unaffordable.
Savers
For those with savings, higher interest rates mean higher earnings – as long as you stay on your toes. Switching money into a new high-interest account often makes a difference, as many older accounts have not raised rates in recent years.
One thing to be aware of is the £85,000 financial services compensation scheme limit, which protects your cash against an institution going bust. It makes sense to spread large pots of savings around because of this.
Another issue is the personal savings allowance. Above this level, you will pay tax on your savings, unless they are in an ISA or pension. For basic rate taxpayers this is £1000, but higher rate taxpayers get just £500, which is easily hit at current rates. This means using an ISA or pension is more important than ever.
Investors
While higher interest rates are good news for savers, with inflation over 10 per cent your investments will still be losing money over time, as no bank is offering rates at above the inflation rate.
Investment may help you to outrun inflation over time, but it is important that you understand the risks of the products you are using, and that they are suitable for your needs as the value of investments can go down as well as up.
20th January 2023
1 https://www.bbc.co.uk/news/business-63977963
2 https://www.bankofengland.co.uk/boeapps/database/Bank-Rate.asp
3 https://moneyfacts.co.uk/news/mortgages/average-two-year-fixed-mortgage-rate-also-surpasses-4/
4 All averages from Moneyfacts press release sent December 16
5 https://www.bankofengland.co.uk/monetary-policy-summary-and-minutes/2022/december-2022
6 https://www.reuters.com/markets/rates-bonds/terminal-confusion-boe-rates-mike-dolan-2022-12-07/
7 https://moneyweek.com/economy/605624/uk-economy-outlook-2023
8 https://www.ft.com/content/81fbdff6-dacb-476b-a4ba-12696e7f7800
9 https://www.telegraph.co.uk/business/2023/01/09/mortgage-rates-almost-triple-nearly-800000-homeowners-year/