Since it was first formed in 1694, the Bank of England (BoE) has set the “base rate” – the interest rate it provides to other financial institutions.
Fluctuations in the base rate may affect the interest you receive on your savings, as well as the cost of borrowing.
Throughout the 18th century, the rate remained stable at around 4-5%. Yet, in the 19th century, interest rates began to fluctuate more, often influenced by political and economic events.
This has remained the case and in recent years, you may have been aware of a significant increase in interest rates.
Indeed, according to the BoE, the base rate increased 14 consecutive times, reaching 5.25% on 3 August 2023.
However, on 1 August 2024, the base rate fell slightly to 5% and has remained at this level since. There is a chance that interest rates could fall further, and this might affect your finances in several ways.
Read on to learn what falling interest rates could mean for your financial plan in the future.
Interest rates could come down if inflation continues to fall
The main reason that interest rates rose in the first place was that the BoE wanted to control high inflation.
Over the past few years, the cost of living has increased significantly and according to the Office for National Statistics (ONS), inflation reached a peak of 11.1% in the 12 months to October 2022.
In response, the BoE raised the base rate. This made borrowing more expensive, meaning that you may have had less disposable income. Additionally, increased interest rates made saving more attractive. The theory is that this encourages consumers to cut their spending, reducing the demand for goods and services and slowing price rises.
Changes to the base rate had the desired effect and inflation began to fall. In fact, ONS figures show that in the 12 months to May 2024, inflation was at the BoE’s annual target of 2%.
Consequently, the BoE reduced the base rate to 5% in August 2024.
Now, the ONS reports that in the 12 months to September, inflation was 1.7%. If inflation remains below the annual target of 2% for a sustained period, the base rate could come down more in the future.
This might affect your financial plan in several ways.
Lower interest rates could make it more difficult to achieve growth on your cash savings
As a result of base rate increases, the average interest rate on cash savings accounts rose considerably in the past few years.
For example, according to Finder, the average interest rate on a one-year fixed-rate Cash ISA in October 2021 was 0.41%. By October 2023, it had increased to 5.48%.
You may have benefited from these higher interest rates, making it easier to achieve growth on your cash savings.
However, if the base rate falls further in the future, cash savings interest rates will likely come down too. This could mean it’s more difficult to achieve meaningful growth on your cash and inflation may be more likely to erode the real-terms value of your wealth.
For example, if you put £1,000 in a savings account with an interest rate of 5% a year ago, you’d have £1,050 today. If inflation is 2%, the same goods that cost £1,000 a year ago now cost £1,020.
So, although the real-terms value of your cash has increased, inflation has still affected your spending power.
This effect could be more pronounced if cash savings interest rates fall. Moreover, if the interest rate is lower than the rate of inflation, your wealth could lose value in real terms.
That’s why it’s important to shop around and move your savings to find the best interest rates. Additionally, you may want to reconsider how much of your wealth you hold in cash savings.
While it may be beneficial to hold a certain amount of cash in an emergency fund, if you’re looking at saving over a time horizon of five years or more, you could consider investing more of your wealth. This could give you the potential to achieve growth that beats inflation.
For example, earlier figures from Finder showed that the average interest rate on a one-year fixed-rate Cash ISA between January 2011 and January 2024 peaked at 5.48%. That said, interest rates were significantly lower than this for much of that period.
In comparison, Curvo reports that the compound annual growth rate of the FTSE All-World Index – a global index of mid- and large-cap stocks – was 10.12% between September 2003 and June 2024.
As such, you may want to consider investing more of your wealth instead of holding too much cash, especially if interest rates come down in the future.
Your mortgage costs could come down in the future but may not reach previously low levels
When interest rates rose, many homeowners faced a significant increase in their mortgage costs. Those who were on a variable rate might have seen their interest payments increase right away.
Additionally, if you were on a fixed-rate deal and it came to an end, you may have seen your monthly payment rise when you remortgaged.
In June 2024, the BBC reported that around a third of mortgage holders in the UK were still paying an interest rate of less than 3%. This means that a significant number of homeowners are likely to see their mortgage costs rise in the future when their fixed-rate deals end.
Now that the base rate has fallen, and further decreases could come, you might be hoping that mortgage interest rates will fall too. Unfortunately, the situation is not as simple as this.
According to Money Week, mortgage rates fell after the base rate reduction in August 2024, and some lenders began offering deals with interest rates below 4%. However, several providers have increased their interest rates again since then.
Additionally, the BBC reports that the chief executive of Lloyds Bank said interest rates are “going to continue to come down, but getting back to the level we saw in the last decade where interest rates were down at zero I think is unlikely.”
As such, you may still face increased mortgage costs in the long term and it’s important that you account for this in your budget.
Get in touch
If you’re concerned about how falling interest rates could affect your finances, we can help.
Please give us a call on 01276 855717 or email info@braywealth.com today.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
The value of investments and any income from them can fall as well as rise and you may not get back the original amount invested.
Past performance is not a guide to future performance and should not be relied upon.
An ISA is a medium to long term investment, which aims to increase the value of the money you invest for growth or income or both. The value of your investments and any income from them can fall as well as rise. You may not get back the amount you invested.
Your home may be repossessed if you do not keep up repayments on your mortgage.
Approved by the Openwork Partnership on 31/10/2024
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