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How an interest rate rise would impact you

This week’s big headline grabber was the US Federal Reserve’s (Fed) hotly anticipated interest rate rise of 25 basis points to a range of 0.75-1%. This is the Fed’s third rate rise in just over a year, but rates are still historically low and Fed Chair Janet Yellen’s dovish tone suggests she’s not looking for a sprint finish just yet.

The Fed’s latest tightening injected a shot of caffeine into the FTSE 100, London’s 100 largest companies index, disrupting its latest slumber and shooting it to a new record high. Great news for those who invest in the index.

But it’s what happened this side of the pond that really caught my attention, and it was all down to Kristin Forbes.

You might not recognise the name, but Forbes is an external member of the nine-strong Monetary Policy Committee (MPC) – the body that sets rates in the UK. This week she voted to raise UK interest rates.

If you’ve been following Forbes it probably didn’t come as a surprise; in February she admitted she was “uncomfortable” with ultra-low rates, warning that the committee would raise rates on the back of solid growth and higher inflation.

They didn’t this time as Forbes was the only member to vote for the increase, but there are whispers that other members agree with her. It’s a far cry from the negative rates spoken of after the European referendum, so could the tide be turning?

Cheap money

Rock-bottom interest rates are bad news for savings – we know that – but it’s often  great news for those who want to take out mortgages and loans as it’s cheaper to borrow money.

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There’s certainly been more dinner talk of buying property, whether it’s my friends finally getting their foot on the housing ladder or those looking for a bigger home. In January, homeowners borrowed more than in almost any month since the financial crisis.

With money so cheap, it’s easy to spend and I’ve had to dish out a stern warning to my plastic-loving friend. He’s not alone though, £15.6 billion was spent on credit in January – although most were savvy enough to pay it back within the month. Traditionally expensive personal loans are also looking cheap¹.

It’s clear that low rates are having the desired impact; the UK consumer is spending more, which in turn strengthens the economy.

Realistic rate rises

This isn’t the first time an MPC member has voted for a rate rise but, as Forbes is leaving her job in June, her voice should only cause a small ripple for now. However, as inflation gets closer to the MPC’s 2% target – it’s forecast to run at 2.4% this year – rate rises will become more real. I’ve heard that some financial heavyweights have pencilled in a 0.25% rise for early 2019, which is still a way off.

The question is whether households will be able to stomach the impact of a meaningful rate rise on their loan interest. Bad spending habits can be hard to break and even the most financially aware will feel a strain.   

This certainly isn’t a saver’s environment, but households should be putting more away today to soften the blow of any rate rise when it does come. With the annual ISA allowance increasing to £20,000 from April, making the most of a stocks and shares ISA could help maximise your return.

¹ House prices rise as record low interest rates drive up mortgage lending, 1 May 2017, The Telegraph

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