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Why interest rate changes affect your investments

November 2017


Tags: Macro Economics

Low interest rates, in the UK anyway, have become a part of the fabric of life.

But in November of this year, the Bank of England finally made a move upwards - an 0.25 percentage point increase in the base rate that puts interest rates at 0.5 per cent.

To put current interest rates into context, in 1990, the Bank rate was at 14.875 per cent. It hovered at around the five per cent mark for most of the nineties and mid noughties. So have we got used to an unsustainable cost for money, how has it affected our spending, and what will happen if rates continue to rise?

 

Low rates discourage saving…

A low interest rate environment encourages us to spend money, especially if inflation is rising at the same time.  Not putting money into a savings account seems like common sense at a time when money in a best-buy savings account effectively loses value because inflation is running at a faster rate than the interest that you are earning it.

Small wonder, then, that the household savings ratio - the measure of how much of our income we save, has remained relatively depressed, falling from highs of 15.5 per cent in the mid nineties to nearer five per cent in recent years.

 

And encourage debt…

When interest rates are low, it is cheaper to borrow, whether you are using mortgages, credit cards and personal loans. That’s good news for homeowners, but it can also encourage people to take out debt that might be unsustainable if rates rise. The most recent consumer borrowing figures suggested that we are taking on debt at a fast rate. The pace of annual consumer credit growth was 9.9 per cent in September, with borrowing on credit cards, overdrafts and unsecured loans all rising.

Organisations such as Citizens Advice are warning that our addiction to debt is unsustainable, while the Bank of England has warned of a ‘spiral of complacency’ around consumer debt.

With interest rates low, investing can help you get more from your cash.  Discover why investing should be at the top of your to do list.

What should we think about when rates rise…?

Interest rates can’t stay low forever. In an environment where interest rate rises are likely, there are several things you ought to consider. Rate rises are likely to impact many aspects of your financial planning, so look at the following.

 

Your debt

In an environment where rates may rise, the first thing to look at is your debt. Ensure you are comfortable with your mortgage rate, and, if you are on a variable rate with no penalties consider switching to a fixed deal or overpaying while you can to ensure you are ready for a rate rise. Take stock of your unsecured debt, as well, and prioritise paying off the most expensive debt first, to ensure you are in a good position if debt becomes more expensive.

 

Your investments

On the investment side, interest rate rises tend to have a dampening effect on the stock market, because companies have to pay more for their debt and this affects their earnings. They also affect the price of bonds, which become less attractive compared to cash savings as rates rise. Looking globally may be a good idea when the UK environment is uncertain. A well-diversified, global portfolio should help to insulate you against UK rate rise risks.

 

Your cash savings

Finally, with your cash savings, check that you are on the best rates and don’t lock your savings away for too long. You might regret that five-year fixed rate if rates rise sharply, as banks will reprice their best value savings accounts to reflect rises. Look for shorter term best buy rates and ensure you move your money at the end of the term on fixed rate deals to get the best deals possible.

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Selftrade does not provide investment advice. This article is the authors view and is not the view or opinion of Selftrade and Selftrade accepts no liability for any loss caused as a result of the use of this information. The opinions expressed are those of the author at the time of writing and should not be interpreted as investment advice.

The value of investments can fall as well as rise and any income from them is not guaranteed and you may get back less than you invested. Past performance is not a guide to future performance. We do not provide advice or make recommendations about investments. If you have any doubts about the suitability of an investment, you should seek advice from a suitably qualified professional adviser.

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*Source: LIBF & 7IM, 2018.