- It’s two years since the Bank of England started raising interest rates on 16 December 2021
- House prices are still higher than they were two years ago
- The effect on mortgages, savings accounts and bonds
- Interest rate expectations
Laith Khalaf, head of investment analysis at AJ Bell, comments:
“The market is now pricing in some pretty hefty interest rate cuts in the second half of next year, taking us back to 4.5% by the end of 2024. It really didn’t take very long for markets to move from calling the peak in interest rates to getting excited about rate cuts. While lower rates would be good news for homeowners and businesses, hopes must be tempered by the foggy and contested nature of macroeconomic forecasts. Markets are pricing in cuts next year, while the CBI has said it doesn’t expect the Bank to lower rates until 2026. This neatly encapsulates the divergent views that are commonly reached on the economic outlook.
“Much of course depends on the path of inflation, which is driven by many variables that are difficult to predict in isolation, let alone together. That’s especially against a background of monetary policy going from nought to sixty in a painfully short space of time, with much of the attendant effect on the economy yet to play out. With inflation still way above the Bank’s 2% target and pay growth still elevated, it feels premature to be pencilling in rate cuts in all but the lightest of shades.”
Two years of interest rate hikes
“As of 16 December it will be two years to the day since the Bank of England started raising rates from a rock bottom 0.1%. The actions of the central bank have totally transformed the monetary landscape, and the most painful and widely felt impact has probably been in the mortgage market – the typical two year fixed rate rising from 1.6% in December 2021 to 5.3% today.
“Despite the huge shift in mortgage rates, house prices are still higher today than they were in December 2021, when base rate was close to zero. Part of the reason for house prices remaining elevated is that rising interest rates have a lagged effect on the property market, especially given the popularity of fixed term mortgage deals. That explains why house prices kept on rising for eight months after the first interest rate hike.
“Unfortunately that means there’s plenty more mortgage pain in the post. Research from the IFS and Citi suggests we are only around halfway through the cumulative rise in housing costs since the beginning of 2022, and the peak won’t come until the beginning of 2025. That is echoed by the Bank of England’s estimate that over half of the impact of the last two years of interest rate rises is yet to be felt. We might have reached the peak of the interest rate cycle, but we’re not out of the woods by a long shot.
*Average based on 75% LTV
**Nationwide House Price Index
Sources: ONS, Nationwide, Bank of England, cash rates include unconditional bonuses
“The flip side of mortgage rates rising is so are cash savings rates. After over a decade of near-zero interest rates, savers may be forgiven for thinking they’ve never had it so good. Of course that’s a bit of a mirage, because the current level of rates was quite normal if you look back before the financial crisis. Despite much more competitive rates being offered on cash, over £253 billion remains in accounts not paying any interest, according to Bank of England data. That number has only dropped slightly since December 2021, when an interest rate of zero wasn’t so different to what you could expect from the average savings account. The fact this figure hasn’t significantly shifted in the face of rising interest rates suggests banks continue to provide accounts that pay no interest, and consumers aren’t actively seeking alternatives.”
Bond fund blow-out
“Higher interest rates have also taken their toll on bond prices, and as a result, on funds which invest in bonds. Government bond funds in particular have been hit especially hard, with the typical gilt fund falling by 25.8% in two years. To see gilts falling quite so steeply will have come as a shock to some investors, as these bonds are usually held for their safe haven status. Often they are held as part of a multi-asset strategy, and in a bit of a role reversal, it’s been the equities acting as ballast over the last two years.
“Annuity hedging funds have also seen a huge drop in value. These are funds which are used as part of a pension lifestyling strategy, whereby investors are automatically shifted out of shares and into bonds as they approach retirement, in order to hedge annuity rate movements. Pension savers who are actually going to buy an annuity with their pension might be sanguine about seeing a chunk of their pension savings disappear just as they approach retirement, seeing as they will benefit from higher annuity rates. Then again, they might not. Those who are planning to draw their pension as cash, or to keep it invested, won’t see any offsetting benefits from higher annuity rates. Instead they will be left with a much smaller pension fund, and little or no time to make amends.
Source: FE to 8 December 2023
“The good news, such as it is, is that after such a massive repricing, bonds are actually offering reasonably attractive yields once again, after years of providing little return for the risks involved. Bonds now provide income-seekers and diversifiers a much more appealing investment option, but that will be cold comfort to longer term holders who have seen the value of their bond holdings pummelled by higher interest rates.”
