3 significant ways rising interest rates could affect your money this year

The UK’s financial landscape has shifted significantly since the Covid-19 pandemic began in March 2020 – particularly when it comes to interest rates.

Since the pandemic began, the Bank of England (BoE) has raised the base rate of interest 12 times. These hikes have come in response to the climbing inflation the UK has seen in the past three years.

Indeed, the Office for National Statistics (ONS) shows that when Covid-19 arrived in the UK, inflation stood at 1.5%. By March 2023, inflation had reached 10.1%, after peaking at 11.1% in October 2022.

Inflation is measured by the Consumer Prices Index (CPI), which looks at the price of a “basket” of more than 700 goods and services in comparison with the previous year.

So, after reducing the base rate to just 0.1% in March 2020 to support businesses in a challenging economic time, the BoE has gradually increased it to 4.5% as of May 2023, and could choose to hike it further when the Monetary Policy Committee (MPC) meets again.

Pushing up interest rates works, in theory, to lower consumers’ disposable income, curb public spending, and bring prices down to the BoE’s target inflation rate of 2%.

Rising interest rates can have numerous effects on different areas of your finances – so if you’re looking to see the big picture, you are in the right place.

Here are three significant ways rising interest rates could affect your money this year.

1. Your cash savings may see better returns than in the previous two years

Beginning on a positive note, your cash savings might finally be seeing more impressive returns after some years of meagre interest.

Of course, interest rates on cash savings accounts don’t always move in line with the base rate – they are altered at the institution’s discretion. Nevertheless, interest on savings accounts has risen in many instances since the BoE began hiking the base rate.

For instance, Moneyfacts reports that, on 18 May 2023, the best interest rate on an easy access savings account was 3.71%. Whereas, a March 2020 report from Which? shows the highest rate on an instant access savings account was just 1.2% at that time.

So, while interest might increase your expenditure in other areas, your cash savings could be experiencing a higher interest rate, bringing some relief.

It is important to note, though, that while inflation remains in double figures, it is unlikely the interest earned on your cash savings will outpace it. Speak with a Financial Planner for help with inflation-proofing your wealth over the long term.

2. Increased interest could interfere with your tax circumstances

If you have substantial wealth in cash savings, an increase in interest rates might come as fantastic news.

Imagine you had £50,000 in cash. If this £50,000 earned 1.2% interest, as it might have back in 2020, you’d make £600 in interest that year.

Fast forward to 2023, and your interest rate is now 3.7%. Instead of £600, your £50,000 sees a £1,850 return.

Despite these positive effects, it is crucial to be aware of how substantial interest earned on savings could affect your tax situation. If the interest earned on your savings exceeds the Personal Savings Allowance, you could be liable to pay Income Tax on the amount.

Here’s how the Personal Savings Allowance works, as of the 2023/24 tax year.

• Basic-rate taxpayers have a £1,000 Personal Savings Allowance. This means you can normally make £1,000 in interest on cash savings before the interest earned is liable for tax.
• For higher-rate taxpayers, the Personal Savings Allowance stands at £500.
• Additional-rate taxpayers do not have a Personal Savings Allowance.

So, returning to our previous example of the £1,850 earned on your £50,000 savings as a basic-rate taxpayer, in this instance, £850 of this sum could be added to your Income Tax bill for that year.

As a higher-rate taxpayer, £1,350 of the sum may be liable for tax, and at the additional rate, the entire £1,850 could be subject to Income Tax, at your usual rate.

Crucially, if you sit in the top end of your current tax band, this additional interest could push you into a higher tax band altogether, increasing your overall Income Tax bill significantly.

While this news could be worrying to you, don’t panic. Consulting a Financial Planner about your situation in plenty of time, and creating an investment strategy that could diversify your wealth and make the most of tax-efficient savings such as ISAs, could prevent your cash from breaching the Personal Savings Allowance.

3. Borrowing is likely to be more expensive than it was in 2020

Finally, understanding how rising interest rates could affect any loans you take out is also important – particularly when it comes to mortgages and credit card debt.

Indeed, after the base rate was reduced to just 0.1% in March 2020, Moneyfacts reports the average two-year fixed mortgage rate stood at 2.44%. Three years later, in May 2023, Moneyfacts now shows the majority of two-year fixed agreements are priced at 4% or more.

Similarly, you could face higher interest rates on credit card debt than in the previous two or three years. This could subtly yet noticeably increase the pressure on your finances in the months ahead, so it’s important to remain vigilant about spending during this time.

If you are concerned about maintaining your budget as interest rates rise, your Financial Planner can help bring you peace of mind. We can review all areas of your wealth and create a comprehensive financial plan that helps you see the big picture in a time of rising costs.

Get in touch

For a discussion about how rising interest rates may affect your money, email us at enquiries@pen-life.co.uk, or call 1904 661140.

Please note

This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

All contents are based on our understanding of HMRC legislation, which is subject to change.

All information is correct at the time of writing and is subject to change in the future.