What Are The Benefits Of Rising Interest Rates?

Interest rate rises are generally considered bad for homeowners – particularly those who have large mortgages. But rate increases are a tactic used by the Bank of England (BoE) to try to rescue the economy. So, what are the benefits of interest rate rises?

Lower inflation

The BoE’s decision to raise interest rates from the record lows enjoyed in recent years came as a result of rising inflation. In October, inflation (which is the main indicator of the rising price of consumer goods and services) was higher than 11% and was a major contributing factor in the ongoing cost-of-living crisis.

Increasing interest rates reduces disposable income and, as a result, consumer demand. Inflation had dropped to 10.7% in December 2022 (the latest inflation report is due on 18th January 2023). This indicates prices are falling and inflation is being brought under control – although this is a long-term strategy, not a quick fix.

Increased savings rates

Higher interest rates encourage saving. Rate rises are not always passed onto savers straight away, but as some banks start to offer enhanced rates, others follow suit. So, now is the time to compare savings rates across the market and look at switching cash savings to where they will offer maximum return, such as Cash ISAs, for example, which also offer tax-free interest returns.

Those who have money they’re happy to put to one side may want to consider investing in fixed term bonds. These are generally risk free, but banks offer higher interest rates as an incentive to tie savings in for a period of time (typically between two and five years).

Higher annuities for those set to retire soon

Annuity payments are worked out according to interest rates. And this means further rises could benefit those looking to retire in the coming months.

Providers of annuities tend to invest in gilts (government bonds) which see yields increase as rates go up. One of the benefits of an annuity is that once you lock in a rate, it’s set for life. So, those buying annuities while rates are at their peak could see their retirement income exceed previous expectations.

A stronger pound

Higher interest rates also encourage foreign investment in the UK. In turn, this helps strengthen the pound against other currencies. This is good news for people going on holiday, as they may benefit from better exchange rates.

It can also help businesses that deal with overseas suppliers and clients.

Diversified investment portfolios

While rising interest rates don’t necessarily have a direct impact on investments, the increased focus on savings can encourage people to revisit their investment portfolios. The UK recession that began in 2008 continued for five quarters and affected many.

But those with long term investments may have experienced this as a more of a temporary blip than as a significant event. This is because their investments are designed to provide returns over many years and are, therefore, somewhat protected against short term economic problems.

So, now could be the time to speak to a financial advisor about diversifying your investment portfolio.