What would happen if interest rates rise?
After more than five years at record low levels, an interest rate rise could be on its way. But why has the Bank of England suggested it and what effect would it have?
What a difference a month makes.
In May the Bank of England governor seemed eager to dispel speculation of an interest rate rise, insisting that rates would remain low “for some time”.
But this week Mark Carney suggested quite the opposite: that the first rate rise in more than five years could “happen sooner than markets currently expect“.
The government will be keen to frame this as further evidence of an economic recovery. But there is a deeper fear.
As London’s property market continues to race ahead entirely disproportionately to the rest of the country, many believe an ever-growing housing bubble has the potential to burst.
Those fears have been compounded by intenational observers. The International Monetary Fund (IMF) has already warned that house prices pose a threat to Britain’s economic recovery, while the European Commission has called for the government to rein in its help to buy scheme.
An interest rate rise could be the perfect tonic.
Risks
But for many whose financial lives have been shaped on the current 0.5 per cent rate, that is a move fraught with risks. British households remain some of the world’s most indebted. The Resolution Foundation says many are still paying off debts incurred during the boom years.
The think tank predicts that around one million households would face extreme levels of debt if the Bank of England base rate eventually rose to 3 per cent, with two million forced to spend more than half their monthly income servicing their mortgage if rates returned to 5 per cent – the figure before the financial crisis.
Worst hit would be holders of interest-only mortgages who revelled in huge falls in monthly costs during that time. The householder whose tracker mortgage follows base rate plus 1 per cent would see the cost of a £150,000 interest-only mortgage rise from £188 a month to £500 if base rates rose to 3 per cent, and to £750 a month if it rose to 5 per cent, the group says.
There is one exception. Many of Britain’s over-60s, especially those with savings and assets, have largely missed out on a decent rate of return during a time of low interest rates. Should the Bank of England instigate a hike before the election, the Conservatives will hope to be rewarded by this group at least.