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How will the US rate rise affect UK borrowers and savers?
Interest rate stories are like Groundhog Day scripts. Each time, it's the same “they can't stay low for ever and must go up soon” words, but they remain stubbornly at rock bottom - unrewarding for savers but good for borrowers.
Now, after nearly seven years of ultra-low levels in the UK, and similar near zero numbers in the United States and the Eurozone, it could be different. Just before Christmas, the American Federal Reserve pushed up rates by 0.25 percent.
It's the first increase in a decade, a period marked by the worst financial crisis in living memory, and “quantitative easing” (or printing money) where the Federal Reserve printed around $3.5 trillion to prevent the US economy collapsing. North American markets now expect more similarly low scale increases over the next 12 to 18 months.
The big questions for UK savers, or – on the other side of the fence – home buyers or credit card borrowers, are whether and when the Bank of England follows the US lead, and how that translates into savings and loans rates.
The Americans feel confident enough about the strength of their own economy to signal rising rates. There is little US unemployment so wage rates are on the up, the dollar is strong, and consumer spending is increasing – all signs that an interest rate uplift is needed to apply control. Central bankers do not want to let good news go unfettered – they see that as the route to high inflation and worse.
Over here, the Bank of England stresses “there is no mechanical link” between a US decision and what it does. Financial markets expect nothing much to happen in the UK until this summer or even early 2017.
However, UK authorities have two substantial reasons to either raise rates or signal their intention to do so. Firstly it is a sign of confidence, that more than eight years after the collapse of Northern Rock, the economy is strong enough to return towards normality. Earnings are rising faster than prices and shoppers are returning to the high streets (or their phone screens).
Economic recovery is a message the UK authorities want to put across. And at some stage over 2016, recent falling raw materials costs – oil, commodities, will drop out of the inflation equation. A small rate rise would tell markets that the Bank of England's has no intention of letting prices go up too strongly – interest rate rises hold back spending because they make it more costly to borrow to buy items, although the danger is companies holding back on investment.
Secondly, it would tell the housing market, especially in London, to pause and think. The Bank is worried about house prices and fears a bubble. Higher mortgage rates should dampen buy to let enthusiasm (adding to the effect of tax increases), while foreign cash buyers may think twice as a rate rise could increase sterling's exchange rate value, making UK purchases less attractive. There should still be a number of good value fixed rate home loans, especially for the more credit worthy – those who can afford a hefty deposit.
But significant UK rate rises are far from certain. Even if they do occur, banks may not pass them on to savers as we are squirelling away our money anyway, believing that future days are more likely to be rainy than sunny. So they do not need to push returns higher to encourage us to save more. Figures from the Bank of England show we now have £164 billion in zero interest accounts.
Numbers from financial analysts Lipper show that, adjusted for price rises but excluding tax, £10,000 invested in October 2008, when the banks were failing, is now worth £9,170 (at the start of December). To gain, savers had to risk the stock market where the same £10,000 in the average UK share fund was valued at £16,430 (after inflation) in early December or just over £19,000 in cash terms.
Stockbrokers Hargreaves Lansdown calculate low rates have cost savers £150 billion. While the expectations for the coming year are for some mortgage rate increases, it could well be more Groundhog day misery for savers.