By: BILL BLEVINS
Financial Correspondent, Blevins Franks
NOT TOO long ago a hot topic at UK dinner parties was property prices. Today it is interest rates and there is much speculation as to how high they will go.
The Bank of England raised interest rates at their meeting earlier in July. It was the fifth rise in less than 12 months and the current rate of 5.75 per cent is the highest for six years. The key reason behind the rise, and all the recent rises, is inflation.
Inflation (as measured by the Consumer Price Index) actually fell from 3.1 per cent in May to 2.5 per cent, but this is still higher than the bank’s target of two per cent. Utility bills have fallen but other inflation risks remain: strong economic growth; high borrowing; limited spare capacity and indications that businesses will raise prices.
The bank’s explanation that “the balance of risks to the outlook for inflation in the medium term continued to lie on the upside” led City analysts to immediately predict that there is a further interest rate rise to come. Some believe it is possible rates will reach 6.25 per cent next spring, though much will depend on what effect the current rises have.
If rates do reach six per cent, as predicted, it would mean they are back to the level the Labour Party inherited from the Conservatives in 1997 – an interesting development considering Gordon Brown often used to boast that inflation and interest rates were low under his Chancellorship.
Stop rising!
British business and manufacturers are two groups which do not want rates to rise any further. Although some understood the latest rise had to happen – “the MPC’s brief is to control inflation, not to be loved” – they are calling for a halt to further increases.
The British Chamber of Commerce argues that past rises have yet to take effect: “There will be a tipping point and it will happen very soon. By the time we begin to see evidence of businesses being hurt, it will be too late”.
The Confederation of British Industry says there are “growing signs that the medicine is starting to work” and that businesses are concerned that any move to six per cent would be “overkill”, adding that “it’s now time for the bank to leave a long pause to allow the economy to adapt to these new levels”.
However, much would depend on what the MPC considers to be its biggest priority: inflation or the economy. An economic adviser to Deloitte said: “I would not rule out interest rates rising beyond six per cent. It is becoming increasingly likely that the MPC will consider a slowdown in the economy as a sacrifice worth making in order to secure low inflation.”
Of course another very large group praying for rates to stop rising are those with mortgages and/or loans. On an average 100,000 pound sterling mortgage, homeowners will now have to pay an extra 16 pounds sterling per month. Their monthly repayments have already risen by 64 pounds sterling since last August.
Eurozone inflation
Homeowners with fixed-rate mortgages would so far have been protected from the rate rises. However, as their deals end, their repayments will shoot up.
Savers, of course, will have had a completely different reaction to the rate rise, especially those without any debt. Many retired British expatriates fall into this category and they will now be pleased to see the offshore banks they often use offering higher interest rates.
While this will obviously be beneficial, it is important to remember that the reason why the rate is this high is because inflation is also high. You need to minus inflation from your interest rate to calculate how much you are actually earning and do not forget you need to deduct your tax rate too. At the same time, inflation is reducing the value of the money in your bank accounts, so not only are you earning less than appears on the surface, but your money will buy less and less as the years go by.
Of course, the Bank of England is concerned with keeping UK inflation under control and the interest rate rises in response to this. British expatriates may benefit from UK interest rates on their offshore bank accounts, but their primary concern is Eurozone inflation. This does not mean they are off the hook, however, because inflation continues to be a concern here too.
The European Central Bank (ECB) kept rates on hold at its July meeting (following a rise in June) and inflation stands at 1.9 per cent, right on its target of “below but close to” two per cent. Nonetheless ECB president Jean Clause Trichet has repeated warnings of inflation risks in the Eurozone (rapid economic growth and limited spare capacity) and headline inflation is expected to head higher later this year. A quarter percentage point interest rate rise is expected later this year, possibly in September, as a response.
Be realistic
It is certainly worth looking around to see what interest rates offshore banks are offering now, you could perhaps earn more by switching bank accounts, but do be realistic about how much you are really earning. Even the current rates will not keep inflation at bay over the long-term. And just as interest rates rise, they also fall, so while there is a possibility of them hitting 6.25 per cent in a few years time they may be much lower than this. You need to bear this in mind when planning your retirement years.
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