If you’ve taken out a loan in recent years, you might have noticed the higher cost of borrowing. Or perhaps you’ve been enjoying a higher return on your savings?
Indeed, the Bank of England (BoE) increased the base rate 14 consecutive times between December 2021 and August 2023. Interest rates currently remain at a 16-year high of 5.25%.
Higher interest rates can help ease inflation by encouraging people to save more and spend less.
However, despite inflation finally reaching the government target of 2% in May 2024, the BoE has so far held the base rate at 5.25%, although the BBC has reported that the BoE may cut the rate in August.
Read on to find out more about the potential interest rate cut and learn what this could mean for your finances.
There is a growing expectation that the Bank of England will cut interest rates this year
The base rate is one of the tools that the BoE can use in an attempt to control inflation (the rate of increase in prices over time). If the base rate changes, banks usually change their interest rates on saving and borrowing.
When inflation is high, the BoE typically raises interest rates to help reduce inflation by bringing down demand. As inflation falls, the BoE may hold or lower rates to encourage spending.
The graph below shows how inflation and interest rates have changed over the past few years. Throughout the majority of 2022, inflation and interest rates both increased. However, while inflation has been gradually falling since November 2022, interest rates remain at 5.25%.
Source: BBC News
Since inflation slowed to 2% in May, in line with the BoE’s target, there is growing expectation that the base rate will be cut between August and September.
A recent report by Reuters has revealed that all but two of the 65 economists they polled expect at least one reduction in the base rate in 2024.
What’s more, according to This is Money, some experts are forecasting that interest rates will be cut to 3% by the end of 2025.
3 ways an interest rate cut could affect your finances
1. Returns on your cash savings may fall
In recent years, savers have been enjoying some of the highest interest rates in over a decade.
However, a cut to the base rate is likely to lead to banks and building societies setting less favourable interest rates. If this happens, you may see a dip in your returns.
But don’t despair as you might be able to secure a better rate by shopping around and switching to a different savings account.
Additionally, you could lock some of your cash into a high interest rate fixed-rate bond. This is a type of savings account that gives you a fixed amount of interest for an agreed period – as long as you don’t withdraw your money early.
If your savings rate does fall, don’t forget to make the most of tax-efficient ISAs. Returns on any savings held outside an ISA wrapper may be liable to tax. In contrast, you can contribute up to £20,000 (2024/25) to your ISAs each year, without paying Capital Gains Tax or Income Tax on the interest.
Finally, moving some of your savings into investments could help you build your wealth over the long term. While the real-term value of cash savings can be eroded by inflation over time, investing in stocks and shares could give you the potential for higher returns over many years.
2. Lower interest rates could boost your investment portfolio
An interest rate cut can create optimism in the market so it’s often good news for investors.
This is because lower interest rates make borrowing more affordable for both businesses and individuals. As a result, businesses are more likely to invest in growth and recruitment, which may improve profits.
Similarly, consumers – who may have been budgeting carefully when inflation and interest rates were higher – might be more inclined to spend. Indeed, lower debt repayments and more affordable loans could make it easier to make significant purchases.
What’s more, lower interest rates generally make cash savings a less attractive option. So, some savers might switch their attention to investing instead. As a result, stock prices could rise, potentially enhancing the value of your portfolio.
3. Your mortgage repayments might become more affordable
If the BoE cuts the bank rate, you could see your monthly mortgage repayments fall.
However, this depends on the type of mortgage you have.
If you have a fixed-rate mortgage your monthly repayments will remain the same if the base rate is cut. Indeed, according to the BBC, more than 8 in 10 mortgage customers have a fixed-rate deal. However, about 1.6 million deals are due to expire in 2024 so you might be able to secure a better deal when the time comes to remortgage.
Tracker mortgages follow the BoE base rate. So, if you have this type of mortgage, you’re likely to see an immediate change in your mortgage repayments if the BoE cuts the rate.
If you have a standard variable rate (SVR) mortgage, your repayments are calculated based on your lender’s SVR. So, if the base rate is cut, your lender may reduce your repayments, but they are not obliged to do so.
Get in touch
If you’re uncertain about what an interest rate cut could mean for your finances, we can help you review and adapt your financial plan.
To find out more, please get in touch. Email hello@sovereign-ifa.co.uk or call us on 01454 416653.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.
