Interest rates: ‘Significant increases’ due if inflation persists – how you can prepare

Martin Lewis discusses negative interest rates

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Inflation recently hit 5.1 percent, seeing the biggest increase in around a decade. In light of this, the Bank of England responded by raising the base rate, a move Vasso Ioannidou, Professor of Finance at the Centre for Banking Research, Bayes Business School, argued was both inevitable and sensible.

He said: “This moderate increase is a proportionate and sensible response to rising inflation.

“Central banks need to ensure inflation and inflationary expectations are managed, and with the Bank of England’s target inflation rate of two percent being more than doubled at present its intervention is required.

“As things stand at the moment, small gradual increases seem like the sensible approach. This still means the developing situation with Omicron should be taken into account.

“If decreased levels of consumer spending as a result of the new variant are large enough to put significant downward pressure on prices, then further, incremental rises may not be necessary. I doubt this will be the case, however.”

In how these increases will impact Britons, Professor Loannidou did not foresee major issues with mortgages in the short term, but predicted further interest rate rises on the horizon.

He continued: “A moderate interest rate rise on its own will not prove significant for most mortgages, but the problem comes with rising rates of borrowing at a time where household finances are being stretched by tax rises, possible loss of income from the pandemic and rising energy costs.

“It is likely we will see further small increases as consumer confidence continues to recover, but this could all be thrown out by Omicron depending on its severity over the coming weeks and months.”

Professor Loannidou went on break down what could happen to mortgage and debt holders should more interest rate hikes be introduced.

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He concluded: “On its own, the current increase implies only a very modest increase in interest expenses on either new or flexible-rate mortgages. But of course, it also signals that the central bank is prepared to move to more significant increases if inflationary pressures persist or intensify.

“On the margin, this should put downward pressures on real estate prices (e.g., real estate prices may increase at a slower price than otherwise).

“What can people do to prepare? Opt for smaller fixed-rate mortgages. People with floating rate montages could opt for switching to fixed-rate mortgages.

“It is not all bad news. All else equal, higher inflation rates are beneficial to debtors and harmful creditors. This is because debtors pay back the loan in the future when the amount of money they borrowed is worth less (buys less).

“Interest rate increases undo this by increasing the debtors’ borrowing costs and creditors interest income. I think here it is crucial that debtors reduce the volatility of their mortgage payments. The solution to that is fixed-rate (smaller) mortgages.”

The next Bank of England base rate decision will take place in February and Professor Loannidou is not the only one expecting further raises.

Recently, Sarah Coles, a senior personal finance analyst at Hargreaves Lansdown, predicted and analysed what would be the key financial changes to keep an eye on for the coming year.

On interest rates, she said: “The markets are expecting a rise early in 2022. Weak growth figures and the rapid rise of the Omicron variant make the exact timetable difficult to forecast, but we do know that rates are likely to end 2022 higher than they are now.

“Mortgage and savings rates have already been rising towards the end of 2021, as markets started pricing in a rise.

“But while mortgage and credit card rates are likely to rise in the wake of any Bank of England rise, the impact on savings will be far less striking.

“There’s a good chance a number of banks won’t pass rates on at all, while others will only pass on a fraction of the rise, and even then, they could delay it for weeks.

“In this environment, it’s always tempting to become a wait-and-see saver, putting off fixing a savings rate until rates are higher.

“However, the uncertain timing of any rise means that if you put off a switch, and wait it out in a dismal high street savings account paying 0.01 percent, you’ll miss the opportunity for a better rate in the interim.”

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