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Home arrow Finance arrow Is this the beginning of the end for low interest rates?
Is this the beginning of the end for low interest rates?
Monday, 13 November 2017

On 2nd November, the Bank of England increasedthe UK interest rate for the first time in over ten years. Having lifted onlyfrom 0.25% to 0.5%, this is by no means a seismic shift, bringing it back tothe previous historic low set in March 2009 and marking a 104-month run ofrates below 1%. However, this represents a gear change in the Bank's outlookfollowing a decade where down has been the only direction for interest rates.

Is this a sign that theeconomy is improving?

The previous rate change - which shaved off a quarter percentagepoint in August last year - was made in direct response to the Brexit vote. Forsome, this increase is not so much a sign of economic recovery as a removal ofthe temporary ‘sticking plaster' put in place during a time of intense uncertaintyabout the future. Now that the rate is back to its previous low of 0.5%,Britain is simply back to where it was pre-referendum.

The Monetary Policy Committee - which sets interest rates -confirmed that Brexit is having a "noticeable impact" on theireconomic outlook. However, they outlined that better-than-expected UK economicgrowth was one of the drivers behind their decision to increase, along with lowunemployment and resilient consumer confidence.

Many see the rate increase as evidence that the Bank ofEngland has changed course and is preparing for future rate increases. Withinflation (based on the Consumer Price Index) rising - predicted to exceed 3%this month - interest rates are expected to be lifted further to dampeninflation growth.

How can interest ratesaffect inflation?

Generally, low interest rates help boost inflation byencouraging economic activity through cheaper credit, whereas higher rates putthe brakes on creeping inflation by making borrowing more expensive. So diallinginterest rates up and down is one way the Bank of England can achieve the‘goldilocks' zone of 2% inflation required for a balanced economy.

The Monetary Policy Committee indicated that futureincreases would be at "a gradual pace and to a limited extent". They estimatethat two further increases within as many years - lifting the rate to 1% bylate 2019 - could be enough to reach their inflation target amidst Brexitheadwinds. 

What does anincreased rate mean for you?

-         Savingand borrowing

While the increase is relatively small, for savers, any risecan be a boost for money held in bank deposits. Conversely, higher rates canprove costly for those with mortgages and other loans.

But, in practice, the link between the official base rateand savings or mortgage rates is weaker than ever. Although you may benefitfrom shopping around for better available rates, an increase of this size isunlikely to warrant an overhaul of your finances.

-         Exchangerates

In the wake of the announcement, the British Pound dropped1.8% against the Euro to just over €1.12 as investors reacted to the Bank'scautious tone about sluggish growth. Although it recovered, Sterling is likelyto remain volatile during Brexit uncertainty. This serves as a reminder thatyou are at the mercy of exchange rates if you draw income in Sterling whileliving in Europe. Look for investment structures that allow multi-currencyflexibility or consider transferring your UK pension overseas to help minimise exchangerate risk.

-         Pensions

Higher interest rates generate better returns from UK bonds,which are usually used to finance pension benefits.

As a result, if you are looking to buy a retirement incomethrough an annuity, a higher interest rate could potentially boost the amountyou could secure. However, this may not be such good news for those looking tocash-in a ‘final salary' pension. Recent ultra-high transfer values - designedto encourage members to swap generous lifetime retirement benefits for aone-off reward - are likely to decrease as providers find it easier to finance guaranteedpension payments. So if you are considering transferring, take regulated advicesooner rather than later to secure the best possible outcome.

-         Investments

Generally, a low interest rate environment has positiveeffects on share markets. Following the rate increase, the FTSE 100 gained 0.9%,boosted by the weakened Pound.

With interest rates expected to hover no higher than 1% overthe next two years, achieving better returns than money in the bank means considering‘riskier' investments. Although market dips can be unsettling, if you areinvested for the medium to long-term in a well-diversified portfolio you shouldhave less cause for concern. Spreading your interests across different regions,asset types and sectors will limit your exposure in any one area.

In any scenario, how you structure your finances shoulddepend on your unique circumstances, aims, risk tolerance and time horizon, noton speculation of where interest rates may go. Make sure you are best placed todeal with the challenges of the moment - be they prolonged low interest ratesor Brexit uncertainty - with regular financial reviews.


David Bowern,Partner, Blevins Franks
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Tel: 952 809 212


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