After pegging the bottom at an unprecedented 0.25% for a decade, the Bank of England surprised almost no-one on 2 November when it announced an increase of 0.25% to its Bank Rate, bringing the benchmark lending rate to 0.5%
With UK inflation sitting well above the target of 2% for the eighth month in a row in September this year, and with Sterling still relatively weak and energy prices high, the Bank’s reason for increasing the rate is to try in some measure to counter inflation.
With the Bank of England itself estimating that a full 1 per cent rate rise would take 3 years to lower the inflation rate by 1%, a rise of 0.25% can only ever be a token move in this regard.
As Mark Carney has made clear that rates will not be rising much further in any hurry, the impact of the November 2 rise may be more psychological than anything else for most people.
However, judging as we do at PWS that a smart investor keeps an eye on all changes in circumstances and considers their possible impacts carefully, it’s worth considering what effect this small rise could have on your finances and future security.
The impact on your mortgage borrowing.
For homeowners, or buy to let investors, who have mortgage borrowings on a Standard Variable Rate or Tracker Rate linked to the Bank of England’s Bank Rate, the 0.25% rise will be passed on fairly quickly. A borrower with a £200,000 mortgage who has been paying £900 per month, for example, would be likely to find themselves paying an additional £25 per month as a result of the increase.
Almost half of all more recent UK mortgage borrowing, and of borrowing by younger, and more financially adept, borrowers, is in the form of fixed rate deals with 2, 3 or 5 year terms, however. If you have a mortgage of this kind then the increase in Bank Rate will have no immediate effect on your monthly cost.
When your fixed term comes to an end, however, the SVR onto which you will automatically migrate unless you arrange a new fixed term product will be a little higher than it was pre Nov 2.
Similarly, any new fixed rate products to which you may wish to switch are likely to have been priced reflecting the increased Bank Rate. Your main reassurance here is that fixed term borrowing is a competitive marketplace for lenders, and so competition forces prices to be kept keen.
What the rise means for savings.
As anyone with savings is only too well aware, the interest paid by UK banks and building societies had been at rock bottom for as long as the Bank Rate stood at 0.25%.
The Bank of England reported that, before Nov 2, the average easy-to-access high street savings account was paying 0.14% annual interest.
That means that anyone holding £5,000 in this kind of account has been earning just £7 a year. On the back of the Bank’s announcement of the rate increase, the Nationwide, TSB, Skipton and Yorkshire Building Society were all quick to promise increases to their variable savings rate.
If the Bank’s rate rise is passed on, interest on that £5,000 saving should rise by £12.50 a year, making a total of £19.50. This may seem modest in absolute terms, but it’s an earnings increase of 79%.
Other providers appear to be following in their wake of the Nationwide et al, in line with the declared expectations of Mark Carney at the Bank of England.
High street savings accounts are rarely the choice of the savvy investor for anything beyond ‘in reserve’ cash, of course. If one looks only as far as a typical cash ISA, for comparison, a £5,000 investment in there would have been earning around £12.50 a year pre November 2, but should now yield around £27.50, which is an increase of 120%.
How the rate increase affects pensions.
Because PWS are wealth advisers, for whose clients the performance of pensions is always of particular interest, it’s important to consider what this interest rate rise, and any possible subsequent rise could mean for the buying power of your pension savings.
“For an individual looking at his or her retirement options, the increase in the Bank Rate should in principle result in better value for money on annuities,” according to our Private Client Adviser, David Pritchard. “Annuity rates move pretty much in line with the interest rates offered on the long-dated government bonds known as gilts.”
Because the market had been anticipating a rise in Bank Rate, the yields on gilts have been rising for some time. This means that for anyone approaching retirement and using their pension pot to purchase the ‘income for life’ provided by an annuity, the value on offer is relatively high.
David Pritchard urges perspective, however. “I’ve read estimates that a 1% rise in gilt yields – which you’d expect to come from a 1% rise in Bank Rate – equates to as much as an 8% rise in annuity rates. So you can judge the potential impact of the current 0.25% increase for yourself. Annuities currently offer around 4.5%, which is up by close to half a per cent on their level a year or so back. It’s positive, and good news for anyone approaching retirement. I’d just avoid talking too much to friends or relatives who purchased annuities in the nineties.”
At the 1990s high-point to which David refers, those retiring were readily able to buy annuities at around 15% per annum. For anyone with a £250k pot, that meant an index linked pension income of £37.5k a year, which is now worth around £65k a year.
Talk to us about your savings and pension issues.
If this first increase in Bank rate in a decade has caused you to think about any aspect of your savings or pension strategy, talk to your PWS Personal Adviser, who’ll be delighted to expand on the implications recent economic trends could have for you.
If you’re not currently a PWS client, we’d be just as pleased to talk over any questions or concerns with you. You can contact us here.