First UK interest rate rise for a decade, but sterling slumps

In a widely expected move, the Bank of England’s Monetary Policy Committee (MPC) has raised interest rates from 0.25 to 0.5%.

This is the first increase in the base rate since July 2007. Rising inflation, which now stands at 3%, together with strengthening GDP figures in the third quarter, were contributing factors for the decision.

But it is important to remember that interest rates were cut by 0.25% last year to mitigate the risks of a downturn that might result from the Brexit vote, so the current decision is a reversal of that.

The accompanying statement was dovish, however. Gone is the warnings that rates may rise more quickly than markets currently expect. Instead, the Bank says: “All members agree that any future increases in Bank Rate would be expected to be at a gradual pace and to a limited extent.” That’s why sterling fell sharply at midday.

Mortgages

While this will be welcome news for savers, a rise in interest rates puts more pressure on borrowers, and especially those with variable rate mortgages.

David Copland, director of The Mortgage Alliance, comments: “There’s no denying that an interest rate rise is going to be a daunting prospect for many homeowners who are on a variable rate tracker or standard variable rate. This will be especially true for those who have recently got onto the housing ladder.”

He adds that for borrowers approaching the end of their fixed terms and those on trackers, now is the time to look at potential remortgage deals which could offer the safety of a longer-term fixed rate.

Maike Currie, investment director for Personal Investing at Fidelity International, comments: “While rising interest rates are likely to hurt those on variable rate mortgages, it could spell good news for investors who are exposed to cyclical sectors of the economy, in particular banks, as rising rates give them greater potential to make money on the difference between the rates on the loans they make and the interest they pay on deposits.”

Retirees

She points out that many retirees are risk-averse and tend to favour cash, so better returns on cash deposits will be warmly welcomed by them. Further, annuity rates which have been at historical lows could improve with a rise in interest rates, which means those planning on buying an annuity could secure a higher income.

“Less positive is the possibility that retirees could see a fall in the value of their pension funds. This is because when investors near retirement age, pensions savings are often automatically moved out of the market and into bonds, as a way of de-risking pension savings – a process known as ‘life-styling’. But bond prices tend to fall when interest rates rise, in order to increase the yield and attract buyers,” adds Currie.

Steve Webb, director of policy at Royal London, says: “The one group who may be concerned by today’s news are those planning to take a transfer from a final salary pension. Transfer values are likely to track down as interest rates rise.”

He adds that anyone considering a transfer may wish to take impartial advice on the pros and cons of a transfer, as transfer values are unlikely to remain at today’s high levels.

Andy Green, chief investment officer at Hymans Robertson, says: “Many of the longer-term issues facing the UK such as Brexit and a sluggish housing market look set to remain well into 2018 and this move has already been well-flagged in the market.

“In this ongoing environment of low yields and uncertainty, we continue to recommend a focus on assets that can deliver predictable returns with attractive levels of income to deal with pension fund outflows.”

The first in a series of hikes?

Matthew Brittain, investment analyst at Sanlam, does not believe that this is the first in a series of rate increases. Instead, he argues that inflation will return to target levels of its own volition, as the effects of a weak sterling dissipate.

He says: “The UK remains in a precarious economic position with high levels of consumer debt and the Brexit negotiations delaying investment decisions, so we think that low interest rates are helpful in keeping the economy strong. Assuming the inflation outlook stabilises, we think this is the first, and last, interest rate hike we will see for a while.”

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser

Source.