In a previous blog of mine called WHAT THE 200 YEARS HISTORY OF INTEREST RATES TEACHES US I explained that the UK base rate of 0.1% in October 2020 was extraordinarily low compared to the 200 year average interest rate of about 4%.
We have observed a consistent increase in the Bank of England’s interest rate so far this year to tackle rising inflation, with expectations that it will rise to 2.5% this year. Despite the attempt from the Bank of England (BoE) to influence the interest rates of other banking providers, there is still a long way to go as many are yet to pass this on to savers.
Notwithstanding this upward trajectory, 2.5% is still a very low interest rate and would be scarcely half of the typical interest rate in comparison within the Bank of England’s 328-year history.
Experts disclose that we should expect a bank rate of between 4 and 5 per cent should the economy return to what used to pass for ‘normal’ – the official rate of the BoE has a daily average of 4.66% since it was founded.
With this being said, savers can look forward to getting the most from their cash savings in a risk-free manner but only if they shop around for the best rates on the market and construct a safe and diversified portfolio.
At the Monetary Policy Committee meeting on 16th June 2022 the base rate was increased again by 0.25% to 1.25%.
The UK base rate is the interest rate at which commercial banks, like Barclays and Natwest, borrow from the Bank of England.
In theory, lower the interest rate, the cheaper loans become for borrowers, because generally, lenders will base their rates according to the base rate. Similarly, the base rate will generally determine the interest rate at which banks will set their savings account products.
Essentially, low interest rates are generally good for borrowers, but bad for savers.
Below is a graph showing the change in the Bank of England base rate since 1975.
Since March 5, 2009 savers have had a torrid time when the base rate fell to a record low level of 0.5% from 4.5% on October 8, 2008 just 5 months earlier. This was at the time of the Great Financial Crisis in 2008/9. The base rate has only just started rising above the 0.5% level since 17 March this year. That has been a wait of some 13 years for savers to experience an increase in interest rates on their savings.
If, on the other hand, you have been a borrower over the last 25 years or so, you have enjoyed record low interest rates for approximately half of that period of time. You have been extraordinarily fortunate especially if you have been a mortgage borrower because house prices have risen significantly too.
In May 1975 the average price of a house in the UK was £9,423. As of April 2022, the average house price in the UK is £281,161, according to the UK House Price Index.
So what should you do about rising interest rates?
If you are a saver do not invest in fixed interest rate accounts or fixed term bonds. Interest rates are likely to continue rising so you will benefit from high returns by taking advantage of variable interest rates.
If, on the other hand, you are a borrower, especially a mortgage borrower, then you should seriously consider locking in your mortgage to a fixed rate deal and the longer the period the better unless of course you are planning to move within the fixed rate period as you will probably face high penalties for breaking your contract early.
Personally I like 5 year fixed rate mortgages because I have no plans to sell property for the foreseeable future. Moreover, with 5 year fixed rate mortgages of around 2.5% while CPI inflation is currently 9.1% and continuing to rise, I am repaying my mortgage with depreciated money. In real terms my mortgage interest rate is minus 6.6% (2.5%-9.1%). Yes you read that right minus 6.6%! In my opinion this is one of those rare opportunities in life where you are in effect being paid to borrow money, well at least in real (inflation adjusted) terms. This is a once in a generation opportunity.
What if you are both an investor and a borrower like me?
Well the problem with saving your money in a bank account is that if you earn an interest rate of say 1% whilst CPI inflation is 9.1% you are losing money in real (inflation adjusted) terms by 8.1% p.a. (9.1%-1%). Your wealth is depreciating rapidly.
With fixed term mortgage rates so low today, inflation so high and stock markets arguably at very cheap levels, I would recommend investing in a portfolio of shares or in equity funds because history shows that in times of recessions, and global recessions are on the verge of occurring, the largest gains occur on stock markets over subsequent five year periods. Warren Buffett once said it is wise for investors to be “fearful when others are greedy, and greedy when others are fearful.” Certainly many people are fearful currently due to relatively large falls in share prices over the last six months. However, many great companies’ share prices are at rock bottom levels. This is the equivalent to buying great branded goods in TK Maxx at very large discounts. Who am I to argue with the world’s greatest ever living investor? You know it makes sense.*
*The value of your investment can fall as well as rise and is not guaranteed. The contents of this blog are for information purposes only and do not constitute individual advice. You should always seek professional advice from a specialist. All information is based on our current understanding of taxation, legislation, regulations and case law in the current tax year. Any levels and bases of relief from taxation are subject to change. Tax treatment is based on individual circumstances and may be subject to change in the future. This blog is based on my own observations and opinions.