US interest rate rise: how it could affect your savings and your mortgage

A rate rise would be good news for savers

Clare Hutchison
Thursday 17 September 2015 15:20
comments
The Fed Reserve chair Janet Yellen has told Congress that a US rate rise will still happen in 2015
The Fed Reserve chair Janet Yellen has told Congress that a US rate rise will still happen in 2015

Interest rates could rise for the first time in a decade on Thursday, when 12 bankers make a decision in Washington DC that will affect markets around the world.

Those bankers are members the Federal Reserve's Federal Open Market Committee, the US equivalent to the Bank of England's Monetary Policy Committee.

The Fed has been hinting that a rate rise for some time, but recent events, including fears of a Chinese slowdown, may mean they decide to wait even longer.

The decision, said to be on a knife edge, is due at 7pm UK time.

Here's a quick guide to why we should be paying close attention.

Let's start at the beginning. What are we dealing with here?

An interest rate is the proportion of a loan that is charged as interest to the borrower. It is usually expressed as a percentage of the loan outstanding.

As part of their efforts to ensure price stability through control of money supply, countries' central banks set base interest rates and lenders, such as high street banks, tend to peg their products, such as mortgages, to those levels.

Therefore, fluctuations in interest rates can hugely affect our personal finances.

For savers, a higher interest rate means a greater return on cash stashed in savings accounts, but for borrowers, loans and mortgages become dearer.

Unemployment has fallen in both the US and the UK, fuelling speculation that a rate rise is on the way

If central banks are supposed to tinker with rates, why is this particular move so important?

A potential rate hike would be momentous because it would the first time the Fed had taken such an action since 2006.

Like in Britain, rates there have been held close to zero since the depths of the financial crisis in the hope of fostering an economic recovery.

Given the length of time that has passed since the last upward shift, there is a lot of uncertainty about its possible ramifications, especially among the many traders who have never worked under tighter monetary policy conditions.

And again, given it's the world's largest economy in action, whatever those effects, they will be widely felt in the US and abroad.

Why is the Fed considering a move now?

The US economy has been recovering: unemployment fell to 5.1 per cent in August and growth was at 3.7 per cent in the second quarter.

As part of its remit to maintain price stability, the Fed has been monitoring this, as well as the inflation rate.

While inflation is still well below the Fed's 2 per cent target - it slipped 0.1 per cent last month - there is a danger that if the economy continues on this good run, inflation could race ahead in the future.

What's behind the arguments for the Fed to wait?

The Fed also bases its decisions on the health of the global economy and the recent market turmoil on the back of signs of a slowdown and a stock market plunge in China may have given it pause for thought. Plus, plummeting oil prices have kept inflation contained.

This week also saw weaker than expected retail sales and manufacturing data, which may have dampened enthusiasm for an alteration.

The US Federal Reserve chief Janet Yellen speaking to a Senate committee hearing

So what would happen if rates were to rise?

In the US, going by historical patterns, stocks, bond yields and the dollar should rise in the aftermath of a rate increase.

It would spell good news for savers, but for both businesses and individuals borrowing costs would increase. That could curb consumer and business spending, though the Fed has already promised any rate rise would be gradual.

Developing economies may be among the hardest hit for two reasons. First while rates in developed nations have been at rock bottom levels, some investors stored cash in emerging markets seeking higher returns. If there's a upward shift in the US, investors may choose to move their money back there.

Second, many of them hold debt in dollars, which will become more expensive to service.

The euro may also find itself under pressure, given the European Central Bank's recent switch to ultra-loose monetary policy with quantitative easing.

What would it mean for Britain?

It has long been said that when the US moved rates, the Bank of England could soon follow.

Financial markets are not anticipating a UK rate rise until around May 2016, though various pieces of economic data – the return to zero inflation on one hand and strong wage growth on the other – have given cause to believe that that could change.

While there may not be a clear consensus on a date, it's likely that a US move will raise pressure on, or at least expectations for, the Bank of England's Monetary Policy Committee to follow suit.

Those with mortgages may want to take advantage of the wide range of low-rate fixed offers that are around now

Should we be doing anything about this?

Given the possible ramifications for savers and borrowers, it could be worth checking what a rate change would mean for household budgets.

The Bank of England has also said that when rates rise they will do so slowly and steadily, but those with mortgages may want to take advantage of the wide range of low-rate fixed offers that are around now.

Competition has driven mortgage rates down in recent weeks, with some below 1 per cent, but they could start drifting higher again in anticipation of future increases in the base rate.

Join our new commenting forum

Join thought-provoking conversations, follow other Independent readers and see their replies

View comments