Getting ready for higher rates: Savers and borrowers face tricky choices on fixed or variable options, writes Andrew Bibby

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The Independent Online
THE CHANCELLOR, Kenneth Clarke, met the Governor of the Bank of England, Eddie George, on Wednesday to discuss an increase in interest rates.

Their meeting, a symbol perhaps of the ending of the summer silly season, is also a reminder that the autumn could produce financial surprises. The Budget at the end of November is also approaching.

Mr Clarke and Mr George decided to maintain the base rate, which determines banks' own interest rates, at 5.25 per cent, the historical low reached in February after a step-by-step drop from the 1989 peak of 15 per cent.

But most of the City is convinced that the only way now for interest rates is up. Under Treasury orthodoxy higher interest rates are the way to choke down inflationary pressures as the economy improves. The only question, analysts say, is when the rise will take place and by how much.

This might suggest that the prudent borrower ought to anticipate the change by opting where possible for fixed rather than variable interest rate loans.

Conversely, savers may want to be cautious before tying up their money in fixed-rate investments and bonds. For example, today's National Savings returns could quickly look very unattractive.

But having a punt on interest rate movements is complicated by the fact that the markets are already at least one step ahead. The general expectation of a 0.5 percentage point increase in base rate some time this autumn - perhaps after the party conference season - has already been taken into account.

Halifax, Britain's largest mortgage lender, says it will not automatically raise mortgages in response to a half-point base rate increase.

Any increase would be brought in only if investors were leaving the society for better returns elsewhere or if the Government was clearly planning further base rate increases, a spokesman said.

Walter Avrili, of John Charcol mortgage brokers, also believes a half-point increase would have little effect on mortgage rates. He says lenders are anxious not to frighten away borrowers and points out that arithmetic is in lenders' favour when rates are low. 'If you look at the margins at which societies operate, the lower the interest rate the higher the margins.'

While there is general agreement in the City that interest rates are on the move upwards, market predictions that we could be back to 8-9 per cent base rates within two years are less widely shared.

'We are certainly not as pessimistic as the money market. We cannot see inflationary pressures justifying that sort of increase,' Martin Ellis, economist at Woolwich, said.

Margaret Schwarz, chief economist at Abbey National, agreed: 'Sticking my neck out, I would suggest a likely base rate around 6.5 per cent in 12 months' time. The pressure seems to be upwards, but nowhere near what the money markets are suggesting.'

For borrowers who take the pessimistic view, fixing the mortgage is obviously attractive. In sharp contrast to the situation a year ago, the bulk of new mortgage business has moved back to variable-rate deals. Fixed rates increased earlier this year and no longer offer the tempting prospect of immediate short-term savings.

The standard variable rate is at present around 7.64-7.74 per cent, while five-year fixes are typically 8.5-8.7 per cent and 10-year fixes are available at below 10 per cent.

However, Ian McKenna, of the brokers Blyth McKenna, argues strongly in their favour. 'Fixed rates seem expensive compared with what they were six months ago, but in reference to any other period in the past 15 years they are exceptionally good value.'

For savers the reverse calculation is necessary. Locking your money now into a long-term fixed- rate bond may not be such a good idea if interest rates are shortly to go up. However, market anticipation means that to some extent savers are already benefiting from the likely autumn base rate rise.

Abbey National this week took advantage of interest rate speculation to launch what it claimed was the first high street savings product to link the return on offer directly to base rate changes.

The basic interest on its three- year Triple Growth Bond (minimum pounds 10,000) is set at 7.3 per cent for the first year, 8 per cent for year two and 9.5 per cent in year three.

These returns will be increased by 0.25 of a percentage point for each 0.5 percentage point base rate increase, though with a maximum 0.5 percentage point cap each year. The bond is available to existing customers until October.

If interest rates rise sharply:

Your savings will earn more interest, so avoid tying your money now at fixed rates and be cautious about investing in longer-term investments and bonds. Current National Savings returns are likely to be improved.

Borrowing will be more expensive, so avoid over-commitment if you are borrowing at variable interest rates. Borrowing now at fixed rather than variable rates may save money.

Annuity rates historically have moved in parallel to base rates, so it may be worth postponing purchase of an annuity. But the issue is complex, and the longer you put it off the less time you will live to benefit from it.

If interest rates fall or remain at 5.25 per cent:

Short-term fixed rate mortgages are unattractive. Current returns on fixed-rate bonds may be good value.

Inflation is clearly not thought by the Government to be a danger. But, conversely, the economy may be in a worse state that we thought.

(Photograph omitted)

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