Up or down for interest rates?

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by: MarkeD
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Date: Tue, 23 Mar 2010 Time: 10:51 PM
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The Bank of England Base Rate has been at 0.5 per cent for a year now. The only way is up, but the question on everyone's lips is when will rates rise, and how quickly?

For mortgage borrowers and savers the future of interest rates directly affects your monthly repayments and the interest you receive on your hard-earned cash. Unfortunately, interest rates have never been harder to predict than in the current economic environment, but many experts are willing to have a stab.

Question is, who do you believe?

Set to rise

As the economy gains strength and inflation rises, some believe the Bank of England will be forced to hike interest rates. Indeed, December's inflation report showed a massive jump in the Consumer Prices Index to 2.9 per cent, leading many pundits to hastily revise their rate predictions upwards. This is because moving interest rates up and down is one way that the Bank of England can control inflation. As a very general rule of thumb the Bank might increase interest rates to control increasing inflation, or keep them low to avoid deflation.

However, The Bank of England also this month said in its inflation forecast that although it expects inflation to rise above 3 per cent in the near term, it thinks it could fall below 2 per cent later in the year. The Bank stressed there was a high level of uncertainty in medium-term inflation predictions, so the picture is still very unclear.

Ian McCafferty, chief economic adviser at the Confederation of British Industry, reckons they could rise in a matter of months: "As the economy recovers the Bank will have to think about returning monetary conditions towards more normal levels. We expect this to lead to a small rise in interest rates around the middle of this year."

Ben Thompson, director of mortgages at Legal & General agrees: "More bullish elements within the Bank of England have been hinting that interest rate rises are to come later this year and this is looking increasingly likely."

Simon Ward, chief economist at investment managers Henderson New Star predicts rates could rise in April hitting 2.5 per cent by August. And Simon Rubinsohn, chief economist at the Royal Institution of Chartered Surveyors reckons they could shoot to 1.5 per cent by the end of 2010.

If they are right, anyone currently enjoying low mortgage repayments on trackers, discounts and standard variable rates - which move up and down in line with Base Rate - are at risk of significant hikes in their monthly outgoings. (See: Is it best to opt for a fixed or variable rate mortgage.)

One way to avoid getting caught out is to lock into a fixed rate mortgage, where your rate is set for an agreed period, no matter what happens to rates. You will currently pay a premium for such a deal compared to cheap trackers, but you could end up quids-in if the experts above are correct.

But what if they're not?

Low for longer

Plenty of esteemed economists think that the Base Rate will remain low for the rest of this year, if not longer. Some argue we'll remain in a low interest rate environment for up to five years, and if the Bank of England is right that inflation will drop in the medium term, this is more likely.

Ray Boulger, senior technical manager at advisers John Charcol says rates won't need to rise because inflation will drop again: "Despite the much bigger than expected increase in inflation in December the indications that it will fall back to 2 per cent within a year negates the need to take corrective action. With interest rates likely to remain low for some time we continue to recommend tracker mortgages to most clients."

Melanie Bien, director at Savills Private Finance reckons Base Rate will remain at 0.5 per cent for the rest of this year, before slowly rising to 2 per cent over the following two years.

And highly respected economist, Roger Bootle predicts rates could remain below 1 per cent for five years.

If they are right it might not be worth paying over the odds to fix your mortgage rate when you could save hundreds, or thousands, of pounds with a far cheaper tracker deal.

What about savers?

Record low interest rates have cruelly punished savers with pitiful rates of interest - a problem augmented by high inflation.

According to financial research company Defaqto the average interest rate for a £1,000 balance in an instant-access account is 0.88 per cent - well below inflation, which means your money is reducing in value in real terms.

But with savings rates available at over 3 per cent, it's more important than ever you shop around for a great deal.

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