The Bank of England (BoE) increased interest rates from 0.25% to 0.5% on 3rd February 2022. Why have interest rates increased, will they increase again, and how investors can combat rising inflation?
The BoE’s target for inflation is 2%, but at the moment, inflation in the UK is 5.4% in the 12 months to December 2021 – the highest rate for 30 years.
The reason for the high rate of inflation is largely due to the increase in the cost of energy and the price of goods that we import from overseas. Energy prices are not anticipated to come down in the near to mid-term future. Ofgem (the UK’s energy regulator) expects average fuel prices to increase by nearly £700 a year in April.
Why have interest rates increased?
If interest rates are low, the cost of borrowing money is cheaper. This means individuals and companies are more likely to borrow more money and spend more money. When this happens, the rate of inflation rises, meaning the cost of the items you buy gets more expensive, more quickly.
If interest rates are higher, generally people prefer to save rather than spend money. Because they aren’t spending money buying goods, the price of goods doesn’t rise so quickly and the rate of inflation falls.
The BoE’s decision to raise interest rates is in direct response to the rising interest rates – and the BoE forecasts inflation could peak at 7.4% in the spring and sit at an average of 6% for the remainder of 2022. By raising interest rates now, they are trying to bring inflation back down towards the 2% target in the second half of 2022 and during 2023.
The Bank hasn’t ruled out further interest rate rises over the coming months. Some commentators predict the base rate could increase to more than 2.00% by the end of 2022.
What does the increased interest rate mean for mortgages?
As the BoE’s interest rate increases, so too does the cost of mortgages. If you currently have a fixed-rate mortgage this will not affect you and your monthly mortgage repayments will remain the same until the end of your fixed term. If you’re on a variable rate your interest rate will increase as the BoE’s interest rate rises.
If you’re about to buy a property, or re-mortgage now is probably a good time to lock in a fixed-rate mortgage for the next few years. Be sure to shop around for a good deal.
What does the higher interest rate mean for savers?
At the moment, there aren’t great deals around on savings accounts. Just because the base rate goes up, it doesn’t mean that the rate on your savings account will also go up. You need to shop around. The highest interest rates are typically only available if you’re prepared to lock your money into a savings account five for years, and even then the current rates are only around 2%.
Real Estate as a hedge against inflation
Real estate investment is a good hedge against inflation over the long term. An inflation hedge means investing in an asset that is expected to appreciate in value by more than inflation. Real estate is considered a good hedge against inflation for serveral reasons:
- Real estate prices tend to increase with inflation
- As the price of property increases, the loan to value ratio falls, meaning the equity in the property increases. Assuming a fixed rate mortgage, the monthly mortgage repayments remain static
- During periods of inflation, rents also increase, meaning gross rental income will increase
- For those buying property with debt, inflation helps to counteract the interest payments over time: If inflation is on average 2% per year over 30 years, and you have a fixed rate mortgage of 3%, you are effectively only paying 1% per year in borrowing costs
So as inflation and interest rates look set to increase over the course of 2022, real estate provides a good opportunity for investors.
With savings rates so low, inflation, supply and demand imbalances, rising property prices and rising rents and the ability to lock in fixed-rate mortgages at comparatively low rates (and set to rise), now could be a great time to consider investing in real estate.
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