Negotiating interest rate increases

A look at the effect of rising interest rates.

In the Bank of England's battle against inflation its main weapon has been increasing the base rate of interest. The UK's base rate has risen 14 times in succession from a lockdown low of 0.1% in December 2021 to 5.25% now. These increases are designed to squeeze spending power and cool the economy. However, rising interest rates also impact on borrowers, homeowners, savers and taxpayers. Here, we take a look at the effect of rising interest rates.

Fighting inflation

Interest rates are at a 15-year high as the Bank of England (BoE) continues its fight to bring inflation down to its target of 2%.

The latest official data shows that inflation dropped to 6.8% in July from 7.9% the month prior, according to the Office for National Statistics (ONS). The figure was lower than expected, meaning that the Bank may slow down its rate-rising activity.

The Chancellor, Jeremy Hunt, has also pledged to halve the rate of price rises by the end of the year. Mr Hunt described high inflation as 'a destabilising force eating into pay cheques and slowing growth'.

Despite the recent drop in inflation some economists predict that interest rates will need to rise to 7% to tackle the problem.

Squeeze on homeowners

Rising interest rates can significantly affect homeowners, especially those with variable rate mortgages, those looking to remortgage or get a new mortgage. Mortgage lenders often pass on these increases to borrowers, leading to higher monthly mortgage payments.

A typical five-year fixed mortgage deal in the UK now has an interest rate of more than 6%, putting further pressure on borrowers who are hoping to buy a home or reaching the end of their existing deals.

Higher mortgage payments squeeze homeowners' disposable income and reduces their spending power. They can also deter potential homebuyers from the market, which puts downward pressure on property prices.

Silver lining for savers

While rising interest rates can pose challenges for borrowers, they provide a silver lining for savers.

Banks and building societies often take their time to adjust savings account rates in response to rate changes. However, the rate rises are gradually feeding through, and savings rates are at their highest points in years with easy access accounts now over 4.5%, notice accounts over 5% and fixed-term accounts over 6%.

These rates are constantly changing and because they remain below inflation in real terms the money held in savings accounts is shrinking. It is vital to shop around for the best rates possible for your savings.

Late payments and repayments to HMRC

HMRC moves the rates it charges taxpayers for late payments and repayments in line with the base rate.

The tax authority increased interest rates with late payment bills charged 7.75% from 22 August, the highest rate since 2001.

Late payment interest is payable on late tax bills covering income tax, national insurance contributions (NICs), Capital Gains Tax (CGT), corporation tax pay and file, Stamp Duty Land Tax (SDLT), stamp duty and stamp duty reserve tax.

Repayment interest was also increased from the 4% rate to 4.25%.

With rising interest rates, taxpayers who encounter difficulties meeting their tax deadlines may face higher costs due to accumulating interest charges. For businesses, this could result in financial strain, potentially affecting cash flow and profitability.

Shrinking household wealth

The recent hikes in interest rates have caused household wealth to fall by £2.1 trillion over the past year, according to research carried out by think tank the Resolution Foundation.

The report notes that Britain has experienced an unprecedented wealth boom in recent decades, with total household wealth rising from around 300% of national income in the 1980s, to 840% – or £17.5 trillion – in 2021.

However, the Bank of England's rapid rate-rising cycle since late 2021 has caused mortgage rates to rise, house prices to fall and, critically, the price of government and corporate bonds to plummet.

Falling bond prices have reduced the measured value of pension assets (largely in defined benefit schemes, or already in payment), normally the biggest single source of household wealth in Britain.

The Foundation's estimates suggest total household wealth has fallen to 650% of national income in early 2023 – a cash fall of £2.1 trillion over the past year and the biggest fall as a share of GDP since World War II.

Uncertain path

The future path of interest rates is uncertain. Higher rates may be here to stay, or they may return to more manageable levels in the future.

In the meantime, homeowners may find themselves burdened with higher mortgage payments while savers may enjoy better returns on their investments.

It is essential for individuals and businesses to remain vigilant and adapt to the changing interest rate environment, making informed decisions to secure their financial well-being.

Please contact us if you need information or advice on any of the issues discussed in this blog.