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February 11, 2022

What does a higher interest rate environment mean for your investments?

Our analysts put the most recent interest rate rise by The Bank of England into context.

What is likely to happen to interest rates and why?

In December, the Bank of England increased its base rate(which guides interest rates for savers and borrowers) for the first time in over 3 years. (1) The move, from a record low of from 0.10% to 0.25%,came with a warning that more would follow and sure enough, it lifted them again to 0.50% last week (3rd  February 2022).

The aim is to bring inflation (when prices rise, pushing up our cost of living) down towards the Bank’s 2% target. (2)  It is currently approaching 6%, and set to rise further, due to what we want to buy (demand) exceeding what’s available(supply) which increases prices. (2)

As interest rates are increased, the cost of borrowing money does too. This usually means individuals, and companies cut back on their spending, which should bring demand and supply back in line. However, it’s a fine balancing act; if interest rates go up too far, the economy could be tipped into recession, which no one wants to happen.

So, what does it mean for me?

To put things into context, just before the 2007-8 financial crisis, the UK base rate was 5.75% so even if rates were to reach say 1.5% by mid-2023, this would be still exceptionally low by historic standards. (3)  

That said, we are all feeling the pinch. From utility bills to the weekly food shop, with prices outpacing wage rises. (2) After-tax incomes are expected to fall by 2% this year, after taking inflation into account, prompting Chancellor Rishi Sunak to announce a support package to cushion the blow for households. (4)

And the lack of supply (what’s available) is driving up prices too. Anyone wanting to buy a new electric car may find there’s a waiting list and even supermarkets have run out of certain product lines since many countries we import from still have Covid related constraints in place.

However, once factories are up and running again, these shortages may be quickly resolved, helping ease inflationary pressures. And perhaps, fingers crossed, interest rates may not need to rise as much as feared.

Am I making the most of my money?

Savers in the bank should see a small boost to their income, but it’s worth shopping around to ensure you are getting the best rate possible. Whilst we should all keep some cash aside for emergencies and short-term spending goals, don’t forget that you will likely get a negative return after inflation. It’s a good idea to prioritise clearing any expensive variable rate debt, such as credit cards or short-term financing.

Mortgages are the biggest debt burden for many households, although for those on a fixed rate there won’t be an immediate impact. If you are on a variable rate, payments will increase which can quickly mount up if we get several hikes. In such cases, or if your fixed rate is coming to an end, there are still some attractive long-term fixed rate deals around.

How do rate rises affect my investments?

For your investments, it’s not crystal clear and there are lots of variables. As a rule of thumb, interest rates and the stock market often go in opposite ways. When the Bank of England raises rates, it can make it less attractive for businesses to take on additional debt to finance growth opportunities meaning their future profits may not grow as quickly as hoped. However, many companies have built up cash reserves over the past couple of years and may now start to use these reserves to boost growth as the economy gets back to normal and demand picks up.

Interest rates are expected to climb in other countries too, and uncertainty about how high they will go has unsettled global stock markets recently. Equities (shares) fell steeply in January on fears that slowing economic growth would have a knock-on effect on company profits.

However, after the initial shakeout there has been a renewed focus on those companies reporting solid profits and outlook statements. We can’t predict the future, but governments will be keen not to kill off healthy consumer spending and a recovering jobs market.

Keep calm and carry on!

Although we have seen greater market volatility, the important thing is not to panic. Instead take a step back and remember your long-term plans and goals. The funds on the Big Exchange are managed by experienced professionals, so why not let them do the worrying?

The next few decades will see coordinated efforts to decarbonise the global economy and consulting firm McKinsey estimates that a $275tn outlay will be needed by 2050 if we are to reach net-zero carbon emissions. (5)

If you believe, as we do, that sustainable investing is the best way to help the planet and aim to achieve a financial return, funds which adopt this approach should be well placed as we strive to find solutions to today’s challenges.

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 Please remember that when investing, making money is not guaranteed and your capital is at risk. The value of your fund can go down aswell as up. Tax treatment depends on an individual’s circumstances and may besubject to change.  

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