Following the Monetary Policy Committee’s decision to raise the Bank of England base rate to 5.25%, representing the 14th consecutive rise in a row, we consider if elevated interest rates are here to stay for 2023 and factors to consider when looking at debt repayment versus investing or saving capital.
Today’s increase in the Bank of England base rate by 0.25% to 5.25% was not a surprise, being anticipated by both financial markets and commentators alike. By way of context, the recently published CPI inflation figures showed prices rising at an annual rate of 7.9% in the 12 months to June 2023. This is a little lower than the forecasted 8.1% and seems to suggest that inflation might have peaked and finally be on the way back down – although it is still around four times higher than the target rate of 2%.
Markets have therefore currently ‘priced in’ the expectation that interest rates will rise to around 5.75% by September, so this latest move is consistent with overall expectations. It is also in the same direction as recent increases in July to interest rates in both the US (+0.25%), and the Eurozone (+0.25%).
Pay settlement data released on 11th July reveals that average total pay (including bonuses) was up 6.9% and growth in regular pay (excluding bonuses) was up 7.3%. Wages rising at around 7% a year is incompatible with general inflation returning to the 2% target because wage rises and price rises are interlinked. People ask their employers for more money because prices are rising and employers consequently need to raise their prices in order to afford to pay the higher wages. If wages are increasing at 7%pa, that means either that employer profits must shrink by 7%, that prices must rise by 7%, or some combination of the two.
This continues to suggest that inflation is likely to remain ‘sticky’ and find a new equilibrium at a level that is somewhat higher than the official government target. Persistently high inflation will tempt policymakers to push interest rates higher however.
There are also a couple of ‘wildcard’ factors that might have a significant impact on the future path of inflation, and therefore interest rates. The first is whether winter 2023 is mild or cold – the 2022 winter was mild. A very cold winter would increase demand for natural gas at a time when supply is tight, and would probably cause energy prices to surge again, since gas is involved in everything from heating homes to producing food. The other consideration is whether the Russian Navy decides to blockade Ukraine’s ports, following the collapse of the Turkey-brokered grain export agreement. Ukraine has a population of around 44 million but produces (and exports) enough grain to feed 450 million people. Disrupting this supply would have a powerful upwards effect on global food prices, and therefore general inflation.
Taking this all into account, it is likely that a modest number of further interest rate hikes are in the pipeline, though it’s probably fair to say we’re closer to the end of these now than the beginning.
Whilst markets are not predicting any rate cuts at all in 2023, and no significant cuts in 2024, things do look set to ease in 2025. For the moment however, it appears that elevated rates are here to stay, at least for the next year or so.
I am getting an increasing number of client enquiries regarding debt repayment versus investing or saving capital. It’s hard to offer generic guidance on this as it’s quite a complex area and dependent on a number of factors but here are some key areas to consider.
The first one is the debt rate, versus the rate that monies could achieve in savings or investments. With the average rate for a three-year fixed mortgage standing at 6.29% for example then in this scenario, an individual would want to be achieving a higher rate than this, which would currently mean investing with a medium to high level of risk with a long term view and no guarantee of a better outcome.
The second factor is the level of accessible savings that an individual would be left with after repaying the debt. Typically, we would recommend 6 – 12 months’ normal expenditure is kept in an accessible deposit account in case of emergencies.
The third factor is tax position. Somebody paying tax at 40% or higher on their income and then servicing debt at over 6% would probably be better clearing the debt from a mathematical viewpoint. However, this will obviously be heavily dependent on other personal and financial circumstances, such as the availability of accessible cash, health issues and other financial commitments.
Paying off debt can also be quite an emotive issue as many people can see a chunk of capital used to repay debt as money that is lost to them, so it’s a decision that needs to be considered carefully.
However, as interest rates rise, it is definitely a discussion that people should be having and a good reason to speak to your financial planner.
If you need to speak to a financial adviser, please don’t hesitate to contact us.