If you have been following the news over the past few years, you will know that interest rates and their direction of travel have been hitting the headlines. This is because since spring 2022, rates have been heading skyward — and quickly.

While this is often viewed as something for economists and politicians to worry about, rising rates have a direct impact on your savings, investments and your ability to borrow money. Arming yourself with the knowledge of how rates affect you can not only build your financial literacy, but help boost your bank balance, too.

For context, the Bank of England’s base rate (which feeds through to interest rates) was below 1% from 2009 to 2022. Fast forward to today, and the rate has increased 10 times to reach the current rate of 5.25%. 

But why have rates gone up, what do we expect to happen next, and what does it actually mean for your bank balance and savings? Here’s what you need to know.

Why have rates gone up?

To understand why rates have increased, you need to look at inflation. Inflation is the measure of how much the price of goods and services have gone up over time: high inflation means that prices are going up quickly.

Not all inflation is bad. In fact, the Bank of England aims for about 2% inflation each year, so something that was worth £100 in January should cost about £102 the next January.

But prices have been rising much more quickly than this. Inflation hit 11% in October 2022 and has measured above 2% since August 2021. The latest figures showed that prices were 4% higher in January 2024 than they were last year.

To put this into numbers, something that cost £100 in 2021 would cost more like £118 today.

It’s the Bank of England’s job to manage inflation, and one of its tools is interest rates. The idea is that if rates go up, then this feeds through to the interest that is charged on loans (like mortgages) and offered on savings accounts.

If your mortgage is more expensive because you are paying a higher interest rate, then you will have less disposable income to spend. If you can get a good rate in a savings account, you are more likely to put cash away, rather than spend it. 

So rising rates should reduce spending and demand, and as demand for goods and services falls, prices should drop and inflation should fall.

What happens next

Most experts are predicting that the Bank of England’s base rate will not go any higher. It has been kept at 5.25% since August last year, and — as long as there are no nasty surprises in economic data — rates should start to fall in the second half of 2024.

“The direction of interest rates is most influenced by factors such as inflation, wage growth and unemployment,” said Becky O’Connor, from the pensions consolidator PensionBee. 

“It’s expected that rates will reduce to something like 4.75% by the end of 2024. This is not as significant a decrease as was hoped for a few months ago, and the Bank of England is forecasting rates still to be around 4.25% by the end of 2026.”

While the Bank of England’s base rate and its predicted movements have an impact on the rates charged on mortgages and available on savings accounts, it’s not like-for-like. 

For example, the average two-year mortgage rate is 5.73% while the average rate on a savings account is 3.2%, according to the data company Moneyfacts. This means that while we can be fairly confident that mortgage rates and savings rates will come down over the next 12 months, it is less certain when this will happen or by how much.

The mortgage problem

Most people will feel the pinch of higher rates through their mortgage. Even just 1 or 2% added to your rate can leave you worse off by hundreds of pounds a month.

“A mortgage is by far the biggest debt most people carry,” said Sarah Coles from the investment platform Hargreaves Lansdown. “Most mortgages are fixed in the UK, so people have been protected from higher interest rates. However, those coming off a fixed deal are having to find an enormous amount of extra cash each month.”

A fixed rate deal means that your mortgage rate is fixed for a certain amount of time, usually two or five years. At the end of this deal, you typically remortgage onto a new deal at the current interest rate.

According to the Financial Conduct Authority, around 1.5 million homeowners will be coming off the end of a fixed rate deal this year. 

Two years ago, borrowers could secure a mortgage with a fixed rate deal of about 2.4%. If you had a loan of £200,000, this would be about £890 a month. If you had to remortgage today at 5.73%, your monthly payments would be £1,250.

Laura Suter, from AJ Bell, an investment platform, said: “When it comes to your remortgage it’s key to be prepared. Make a note of when your fixed rate deal is up and put a note in your diary for six months ahead.

“The worst thing you can do is let your deal lapse and fall onto the lender’s reversion rate, which can be up to 8 or 9%.”

Sunny savings

The good news is that higher savings rates can boost your finances — as long as you make the most of them.

High-street banks such as Lloyds or Santander typically have lower savings rates, so it is worth shopping around for the best deal for you. Look at comparison sites like Savings Champion to find out where you can secure the best rate.

At the moment, you can get more than 5% on easy access accounts. As the name suggests, you can access this money easily. Some accounts let you take out money three times before the interest rate drops, while others have no limits.

If you are sure you do not need the money, you could opt for a fixed rate bond. The best one-year deal is about 5.2% at the moment. With these accounts, you cannot access the money during the term.

Coles said: “Higher interest rates are great news for savers, who have seen better rates than they have for well over a decade. At the moment, there are plenty of savings accounts beating inflation, so your emergency savings safety net can keep step with rising prices.

“At the moment, the best easy access savings rate is offering more interest than the best one-year fixed rate deal. However, you may want to consider fixing anyway as assuming rates fall from here, you’ll be grateful for having locked in a rate when rates were relatively high.”

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