The Bank of England base interest rate has risen from 0.1% to 1% since December 2021 (see table below), and financial markets predict that rates could rise to 2% by the end of 2022. Inflation is easily outpacing savings rates, a pattern that is likely to continue well into 2023. So what impact will rising rates have on your finances, and what measures can you take?
Interest rates hit a 13-year high
Official interest rates, which are set by the Bank of England and known as the ‘Bank Rate’, are at their highest since 2009, after four consecutive hikes from 20 December 2021. The Bank Rate influences other interest rates, such as on savings accounts and for lending. This, with some lag, affects how much people spend and how much consumer items cost. By raising its interest rates, the central bank is aiming to bring price inflation back under control, in line with its long-term 2% target.
The shredding effect of inflation
Interest rates on savings accounts are only gradually climbing higher, and inflation is forecast to top 10% in 2022, before slowing. If inflation is greater than the interest rate or return earned on your savings and investments then your purchasing power in real terms is diminished. These ‘invisible’ losses mean that £100,000 in your bank account could soon be worth £10,000 less than a year earlier.
Tax-free savings interest
The personal savings allowance introduced in April 2016 means that interest from regular savings accounts is paid gross (before tax is deducted). Higher rate taxpayers can receive interest of up to £500 per year tax-free, while for basic rate taxpayers this figure is £1,000. Therefore, a typical higher rate taxpayer would need to have at least £100,000 in cash ISA savings (based on typical cash ISA interest rates of 0.5%), before the benefit of the tax privilege kicks in.
Savings vs. investments
With interest rates still low, many savers are wasting the tax advantages of their ISAs by keeping large sums in cash ISA accounts, as opposed to stocks and shares ISAs. Investments have a greater chance of beating inflation over long time horizons. Investing requires patience and discipline to ride out the ups and downs of markets. Investors often hold a mix of equities, bonds and other assets. This mix should be reviewed regularly in order to match changes in your risk tolerance and circumstances.
Overpaying on your mortgages vs. investments
Mortgage rates have also risen in recent months, boosting the appeal of overpayments, subject to early repayment charges. Consider alternatives to paying money off your mortgage, such as topping up your pension and lowering your income tax bills. Investment returns after taxes and fees must exceed the mortgage costs over the long run, in order for this to be financially advantageous.
What’s going on with bonds?
Bonds are generally considered safer investments than stocks, but bonds funds have suffered heavy losses as global interest rates have risen. Losses of 10% on UK fixed income funds have not been uncommon in the first few months of the year, and in some cases losses have been double that. Some funds have been more sheltered from this interest rate environment.
Interest rates are still low by historical standards. Consider your options carefully. A well formulated plan with a corresponding investment strategy could provide the answers you are looking for. Call 03300 564 446 to speak to a Lumin expert, or book a free introductory meeting by visiting luminwealth.co.uk/contact.
This article is for general information purposes only and does not constitute financial advice or a personal recommendation. Past performance is not a reliable indicator of future results. Investments can rise or fall in value, and you may receive less than you originally invested. Tax treatment depends on individual circumstances and may change in the future.
