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Interest rate rise to hit borrowers

A rise of just 0.25% to an interest rate of 0.75% is set to hit Britain’s borrowers as slow growth and an uncertain economic outlook continue 

The Bank of England’s interest rate rise, from 0.50% to 0.75%, is set to hit borrowers as the hike increases outstanding debt. An interest rate rise to 0.75% represents the first time interest rates have been above 0.5% since 2009. While this will be welcomed by finance providers and big banks it is likely to have a negative impact on those ‘just about managing’.

The debt charity StepChange released figures this week estimating 3.3 million people in the UK are experiencing severe debt problems and revealed that 620,000 individuals sought their assistance last year.

Outstanding lending to individuals was at £1,592 billion at the end June 2018 according to statistics credited to the Bank of England. Of this £1.38 trillion is secured on dwellings and £213.2 billion represents outstanding consumer credit.

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A rise of 0.75% on a £150,000 variable mortgage would lead to a likely increase of £224 on top of annual repayments. StepChange estimate a £23 rise in monthly mortgage costs alone would push around 1 in 10 of those receiving their assistance into a negative monthly budget. 1.4 million are currently using high-cost credit to get by.

Eric Leenders, managing director of Personal Finance at UK Finance said in a statement last week that “lending to households has continued to grow modestly in line with recent trends, with increased borrowing on credit cards mirrored by a fall in overdraft borrowing,” implying more and more people were being exposed to rising interest costs. The same statement also estimated gross mortgage lending for the total market in June as being £23.5 billion – 2.1% higher than a year earlier.

Rate rise risk

A rate rise was not seen without risk as uncertainty over Brexit negotiations continue to impact investment and the UK’s broader economic outlook. Predictions have ranged from GDP growth being up to 8% lower in the case of a ‘no-deal’, to a forecast of 2% lower GDP growth in the case of a ‘soft’ Brexit. In addition to this, the spectre of a Donald Trump instigated trade war and tremors atop a high equity market underpin a mixed view of the British economy.

However, as unemployment has fallen to 4.2%, its lowest level for over 40 years, the Bank fears competition will create wage inflation, spreading into the broader economy. A rise in the interest rate from 0.50% to 0.75% is seen as a way to hedge further inflation. Currently, the consumer price index inflation indicator (CPI) sits at 2.3%, 0.3% above the government target.

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In reality both savers and borrowers are experiencing different levels of inflation. In April the average two-year mortgage rate was cited as being 2.48% according to The Telegraph & MoneyFacts. The average five-year mortgage rate was 2.91%. Both figures are essentially quadruple the official interest rate. Tellingly the alternative inflation indicator of the retail price index (RPI), is currently at 3.4%.

Savers will also struggle to benefit from an interest rate rise as the ‘deficit’ between inflation and interest remains at almost 1.5%. The Bank of England’s deputy governor, Sir Dave Ramsden, indicated savers cannot expect their banks to pass on the rate rise savings. The reality is most savers are subject to lower interest and higher inflation.

The Brexit clock is ticking for the UK's economy

The Brexit clock is ticking for the UK’s economy

“New economic speed limit”

The rate decision made by the Bank’s monetary policy committee (MPC) represents a consensus that the UK has been set a new “economic speed limit”. Earlier this year, Sir Dave Ramsden detailed the constraining factors of that limit: “Before the financial crisis we were invariably in a ‘two plus two is four’ world, with 2% productivity growth and 2% inflation yielding 4% wage growth at least. Today we seem to be in more of a ‘one plus two is three’ world: given 1% productivity growth, wage growth only needs to reach 3%, not 4, to be consistent with the 2% target. In our central forecast wage growth achieves that. And so although imported inflation falls back as the upward pressure from sterling’s depreciation comes to an end, domestic cost pressures keep inflation close to target in the medium term.”

At the time Ramsden said he expected GDP growth “to resume at a steady but unspectacular pace,” as demand moved from consumption and towards trade and investment. Adding the caveat: “Of course all this is conditional on a smooth transition to the eventual post-Brexit arrangements.”

Pictured top: Mark Carney, governor of the Bank of England

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