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June 3, 2011 6:08 pm

Prepare now for inevitable rate rise

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With Bank of England economists now split on whether and when interest rates should rise, UK households are being advised to prepare different strategies for managing their mortgages and savings accounts.

One member of the Bank’s monetary policy committee, which sets interest rates, told the FT recently that he was in favour of raising rates immediately. Another said that to do so would be “exactly the wrong thing”.

For now, though, the Bank of England has left its base interest rate unchanged, waiting to see if inflation, currently running at double the target rate of 2 per cent, will ease.

However, what all forecasters now agree on is that the base rate will have to rise from its current historic low by the first half of 2012 at the latest – pushing mortgage costs up faster than savings interest rates.

Typically, base rate changes are incorporated into borrowing rates instantly but there is a lag of about a month before they are absorbed into savings rates.

For two years, households have been used to a base rate of 0.5 per cent and have structured their budgets accordingly, warned Vicki Redwood, economist at Capital Economics. She said consumers will suffer a financial shock when the rate does finally move.

Ray Boulger, senior technical manager at John Charcol, the mortgage brokers, said taking out a five-year mortgage, such as Chelsea Building Society’s 3.99 per cent offer, offered protection.

“If you fix now for two years, you will need to fix again at a time when rates will almost certainly be higher,” he explained. “On the other hand, only two banks are offering 10-year mortgages and the price you pay won’t make it worthwhile.”

Financial advisers said that paying down expensive debts now, while rates remain low, remained a sensible strategy for all households. Although those with a clean credit history are currently spoilt for choice when it comes to personal loans, repayment rates are likely to creep up as the market anticipates the first interest rate rise.

In anticipation, Halifax has already announced that it will be linking the interest rates on its credit cards to the base rate. Analysts said they expected to see more ‘tracker’-style credit terms introduced.

For savers, a rate rise is expected to make some difference to the vast majority of accounts paying less than 0.5 per cent on deposits – but is not likely to affect market-leading rates.

“There’s been a lot of media coverage saying that savers shouldn’t fix their money now because rates are going to go up,” said Kevin Mountford at Moneysupermarket.com. But he noted that the best rates are already artificially inflated as the result of competition. Banks and building societies are currently offering customers the chance to earn 4 or 5 per cent on their money if they agree to tie it up for five years. With no guarantee that these institutions will raise these rates further, Mountford advised savers to fix their savings rates now.

Adrian Lowcock at independent advice firm Bestinvest said most of his fund investor clients expected a rate movement at the end of 2011. “Of course, inflation is more worrying to investors than what happens with the interest rate, which will affect debt more,” he acknowledged. “But, if the Bank rate rises then, in order to maintain current bond yields, the capital value of bonds will need to come down by a considerable degree.”

Lowcock recommended strategic bond funds, whose managers are able to react to market changes if rates do move.

Bond fund investors who believe rates will move sooner are also being advised to take a more aggressive stance, and move into high-yield bonds, which are less sensitive to interest rate movements.

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