It has been a challenging couple of weeks for the economy. Many countries are trying to bring inflation down by increasing interest rates. Because higher interest rates mean higher borrowing costs, people will eventually start spending less. The demand for goods and services will then drop, which will cause inflation to fall. But the effect of a high-interest rate is quite significant; it affects our bigger macroeconomic picture and also has a tangible effect on our personal finances.
Here in the UK, the Bank of England has increased interest rates to 2.25% for the seventh consecutive time since December 2021 in an effort to tame spiralling inflation. The move has increased the mortgage costs of around two million homeowners almost immediately. The UK government’s mini-budget, which led to the pound falling to a record low against the dollar, could also trigger another rate rise before the next scheduled vote on the 3rd of November. There is fear the economy is heading for a recession, without significantly easing the cost-of-living crisis.
Today's blog post is about financial awareness. This is what financial literacy is about; a combination of financial awareness, knowledge, skills, attitude and behaviours necessary to make sound financial decisions and ultimately achieve financial well-being. The summary below shows the impact of the rising interest rates on our personal finance:
1️. Credit Cards:
A higher interest rate means the amount of money owed to credit card companies will rise. Many credit cards have variable rates which are not typically explicitly linked to the base rate. History has, however, shown that if interest rates go up, credit card companies will raise their variable rates as well.
2️. Loans:
A higher interest rate means it costs more to borrow money. That means individuals and businesses will not borrow as much in times of higher rates. And when that happens, people spend less and businesses cut costs. In turn, this slows down an economy even more. Rising interest rates put the brakes on economic growth.
3. Mortgages:
Higher interest rates greatly impact tracker, standard variable rate (SVR) or variable mortgage. These products move in line with the base rate, so when it rises, your payments rise, and when it falls, your bills fall too. In the UK, with nearly 850,000 properties on tracker mortgages and 1.1 million on standard variable rates, one in four mortgage customers will see their payments increase.
4. Savings:
In theory, a higher interest rate should lead to higher interest on savings accounts. However, many banks are yet to pass on the last six base rate rises to savers. Those banks that have passed it on have been very slow about it. The average savings rate remains well below inflation (9.9%). So even if your bank passed on the full amount, you would still find your money losing value in real terms.
5. Stock Market:
Higher interest rates tend to negatively affect earnings and stock prices when you invest in equities - with the exception of the financial sector e.g. banks, brokerages, mortgage companies, insurance companies, etc. This industry tends to earn more as interest rates increase because they can charge more for lending. Some seasoned investors would say it’s good to buy equities when stock markets are low. The idea is, you get more for your money and the value of your investments will rise when markets pick up again.
6. Unemployment:
Unemployment refers to a situation in which someone who is ready to work and can work is not able to find suitable employment. Higher interest rates cause a drop in demand and output. If demand drops, businesses will reduce output, produce fewer goods and services, and cut jobs.
We are in for a long ride with the current economic downturn. But there is nothing to fear; this season comes and will eventually go (it will not last forever). What are you doing to recession-proof your finances?
About Nike
Oyenike Adetoye (aka Nike) is an impactful speaker, author and personal finance expert. A Chartered Management Accountant by profession. Nike is the founder and CEO of LifTED Finance, a private financial firm that educates, coaches and supports people on their journey through financial fitness and wealth management.