Better late than never. After ten years of cutting interest rates, the Bank of England has finally got around to raising them, from a pathetic 0.25% to a slightly less pathetic 0.5%. In one sense this is significant: it is a doubling of the base rate. In another it is almost meaningless, so much so that I can barely think of any major actions you should take in response to it.
Look at your savings accounts, for starters. This 0.25% is, I’m afraid, not going to be a life changer. Back in 2007, the last time rates rose, you could get 4.05% on the average instant access savings account. Today, it is 0.39%, says Moneyfacts. Rate rises aren’t guaranteed (banks are not in the habit of passing rate rises on to savers if they don’t have to) and with CPI inflation still running at close to 3%, any cash held on deposit will continue to lose purchasing power every day.
Here’s a shocking number for you, courtesy of M&G. If you’d put £1,000 into a deposit account in July 2007, your money would now be worth a mere £789. If you’d invested it in the FTSE All Share it would be worth £1,297 (again, after adjusting for inflation). So you should watch for rates to rise and take advantage if you see a good deal — but you should also be aware that you probably won’t and that even the best savings deals will still be losers.
On to mortgages. If you have a variable-rate mortgage of £300,000, this rise — if passed on — will affect you to the tune of about £40 a month. If you have an average-sized mortgage of £180,000, it will cost you £22 a month. Not a huge deal.
Better still, most of us won’t actually be affected by rising mortgage rates at all. Either we don’t have a mortgage or we have a fixed-rate mortgage – 60% of UK mortgages are now fixed rate (mine is fixed for five years). The average two-year fixed rate is knocking around historical lows at 2.33% (though it’s perfectly possible to get them at just above 1%). Nice — it was more than 6% back in 2007.
The average Briton is not quite as clueless about money as the financial services industry likes to think. Unless you have failed to fix or are on a high fixed rate there isn’t much for you to do here.
The only mortgaged group who might want to panic a little is buy-to-let owners. They are already finding their cash flows ravaged by the change in the tax regime; they have the ban on letting fees to tenants to come; and their ability to raise rents is limited by what tenants can afford. Recent YouGov research suggested that one in four private renters spend more than half of their income on housing. If all of this pushes your buy-to-let cash flow negative it might be time to sell up.
Next, the stockmarket. This shouldn’t have much of an effect given what a tiny and well-flagged move it is. It is definitely a signal that it is time to shift your portfolio out of stocks that are highly priced simply because they offer a high dividend (this is of less interest when rates are rising than when they are certain to fall) or stocks whose returns are based on borrowing cheap money and spending it on buying back shares. However, I suspect that most readers will have done that already, just as they will also have rebalanced away from the bond market. No one wants to rely on bonds to finance their future when the interest rate cycle is turning.
The only thing I would tell you to do with some urgency is to take advice if you have been considering transferring out of your defined benefit pension: the transfer values on offer will fall as rates rise. You might also watch annuity rates. These should rise as gilt yields rise, so if you do want to buy, the deals on offer should now improve. But those few things aside, there’s not much going on here: you can make a great headline out of the rate rise (Bank of England doubles interest rates after ten years of paralysis) but the reality is that it’s a bit of a personal finance non-event.
So, if this all makes so little difference to the average person’s immediate personal finances, why does it matter? Because while Mark Carney, Bank of England governor, is clearly a half-hearted rate riser and a terrible economic forecaster, it offers some hope that the central banks are beginning to grasp that the side effects of their extreme policies matter (a lot) and so are about to attempt to move into a period of small, slow and steady rate rises.
All the members of the Monetary Policy Committee agreed that future increases will come “at a gradual pace and to a limited extent”. If rates normalise, house prices will at the very least stop rising — and probably begin to fall. That’s going to be particularly the case if this turns out to be a buy-to-let last straw and investors start selling (as I think they already are).
That will deal with the problem we have of intergenerational inequality, the rise in which is almost 100% related to house prices, and the political nastiness it has brought with it.
Rising rates could also deal with a large part of the scary deficits in the UK’s defined pension schemes (once the envy of the world, now the source of wakeful nights for thousands of workers). Last month, Tesco tweaked the assumptions it uses to calculate its pension deficit and in the process brought it down from more than £5bn to well under £3bn.
Imagine how much deficits across the UK could fall if gilt rates were to rise appreciably. Then imagine how much more productive our companies could be if they spent less time holding down wages and holding off investment to divert cash to pension deficits and more time developing their businesses?
The shift could also bring back some confidence to the retail market. Today’s big spenders should be the healthy retired — but would you be free-spending if the only guaranteed long-term return you could get on your capital was under 1%? I suspect not.
This rate cycle is going to be long, drawn out and very uncertain. The UK is hugely indebted; growth is low; and the Bank of England’s models can’t tell us much about how economies react to rates rising from these levels (it has never happened before). It’s a fragile time. But moving rates up is very much the right thing to do.
• This article was first published in the Financial Times