How do rising interest rates affect my money?

After more than a decade of near-zero interest rates, the UK’s base rate has risen to its highest level since the global financial crisis.

The Bank of England might hike interest rates even further, which could have important implications for you and your finances.

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From savings and investments to pensions and mortgages, read on to find out how rising interest rates could affect your money.

Savings

The benefit of rising interest rates is that you might be able to get a higher rate on your cash savings. Some providers are quicker than others at passing on interest rate rises, so this could be a good time to shop around for a better rate. A difference of 0.5% might not seem like a lot, but on large amounts of money it can have an impact. If you put, say, £30,000 in a savings account with a 1% interest rate, you’d earn £300 a year. If the rate was 1.5%, you’d earn £450 a year.

Cash savings rates are still much lower than the annual inflation rate, which measured 7.9% in June¹. Inflation can result in the ‘real’ value of your money declining as price rises erode its purchasing power. For savings over and above your emergency fund, it’s really important to look for ways to mitigate the impact of inflation over time. Although the stock market is volatile, history shows that over long periods it tends to perform more strongly than cash and above the rate of inflation.

Investments

Although rising interest rates are typically considered negative for investments, this doesn’t alter the long-term case for investing. The economy tends to go through different interest rate cycles – sometimes they are relatively low and sometimes they are relatively high – and the timing of these cycles can vary from one country to another. That’s why it’s important to diversify your portfolio, not just by asset class but also by region and sector.

In an environment where interest rates are rising, bonds tend to underperform. This is because most bonds pay a fixed interest rate, which becomes less attractive when interest rates rise. This, in turn, reduces demand for, and the price of, the bond. Bonds with longer maturities are generally more sensitive to interest rate movements than bonds with shorter maturities are, so ensuring you diversify across a range of bonds with varying durations can help to mitigate interest rate risks.

Stocks aren’t directly affected by interest rate hikes, but they are sensitive to them for several reasons. Investors may feel they would be better off leaving their money in cash instead of riskier equities. Higher interest rates can increase the cost of debt for companies and their customers, resulting in reduced profits or a decrease in sales. Rising interest rates also tend to eventually slow economic growth, which has implications for corporate profits. The impact of rising interest rates varies from one sector to another, which is another reason why it’s important to have a well-diversified portfolio.

Rather than basing your investment decisions on interest rates – which are just one factor affecting performance – your best bet is to focus on your long-term goals and ensure your portfolio is managed by an expert with experience of different economic cycles.

Pensions

Rising interest rates boost the amount of income someone could expect to receive from an annuity, which is good news for anyone seeking a guaranteed income in retirement. However, once you’ve bought an annuity you can’t change your mind, so there is a risk you could lock into a rate which subsequently increases. You don’t have to buy an annuity with all of your pension pot, so one option could be to buy annuities in tranches, securing income as and when you need it.

How much income you’re likely to receive is just one factor to consider when deciding how to access your pension savings in retirement. The way you access your pension will be one of the most important financial decisions you’ll ever make, so it’s really important to seek financial advice on the right approach for you.

Mortgages

If you have a fixed-rate mortgage, higher interest rates won’t affect you straight away because the rate is locked in until the end of the deal. Once your deal ends, however, you could find that the mortgage rates on offer are higher than you’re used to paying (this won’t necessarily be the case, as your circumstances could have changed over the years). Those on tracker mortgages or their lender’s standard variable rate will usually see an immediate increase in mortgage costs when interest rates rise. A mortgage broker will be able to explain your options and help you look for the right deal for you.

If your mortgage repayments have increased, this could be a good time to reassess your financial plan. A simple budgeting exercise could help you feel confident that your discretionary spending is at an appropriate level and that you’re saving as much as possible for your future.

Next steps

After experiencing extremely low interest rates for such a long time, the steep rise in rates over the past year is understandably concerning. But this is not the time to panic or make rash decisions. Ultimately, your financial plan should reflect your individual circumstances, including your goals and attitude to risk. This isn’t always clear – and that’s where getting some smart advice comes in. A financial adviser will help you feel confident you’re doing the right thing with your money and that you’re on track to achieve your goals.

¹ https://www.ons.gov.uk/economy/inflationandpriceindices/bulletins/consumerpriceinflation/june2023

The value of investments, and any income from them, can fall and you may get back less than you invested. Neither simulated nor actual past performance are reliable indicators of future performance. Investment values may increase or decrease as a result of currency fluctuations. Information is provided only as an example and is not a recommendation to pursue a particular strategy. Information contained in this document is believed to be reliable and accurate, but without further investigation cannot be warranted as to accuracy or completeness.