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More joy for borrowers, more gloom for savers

Monday 11th July 2016

Written by Martin Upton

The financial consequences of the Brexit vote on 23rd June are already hitting the public. The slump in the value of the pound is pushing up the cost of holiday spending for those jetting off overseas. More significantly developments since the vote seem set to push interest rates lower – to the delight of borrowers and the misery of savers.
The further fall in interest rates relates to fears of an economic slowdown following the Brexit vote allied to the general confusion about the terms under which the UK will leave the EU. This has led to government bond yields falling to further new lows. On 8 July the benchmark 10-year gilt was offering a return to investors of 0.85% per annum. This week the Bank of England’s Monetary Policy Committee (MPC) seems likely to cut the UK’s official rate of interest (Bank Rate) to a new low. Bank Rate has been unchanged at 0.5% since March 2009.
So savers will suffer again. The returns offered on fixed-rate savings products will follow the downward direction of gilt yields. The returns offered on variable rate products are likely to follow the anticipated downward direction of Bank Rate. For those saving for the longer term such developments must surely prompt again the need to explore a diversification in investments to enhance returns.
Clearly, though, these developments are great news for borrowers. The cost of fixed-rate mortgages is linked to the prevailing yields on gilts via the rates on ‘interest-rate swaps’ – a form of financial derivative that banks and other lenders use to fix their cost of funds. So record lows for gilt yields equate to record low rates for the fixed-rate mortgages. Already lenders are competing keenly by offering temptingly low long-term fixed rate mortgages. Those on ‘tracker’ mortgages, contractually linked to Bank Rate, will benefit if this rate is cut further providing the mortgage contract does not stipulate a minimum rate - or ‘floor’ - on the rate charged to borrowers. A fall in the cost of other variable rate mortgage products would also be likely.
Whilst all this seems unfair to savers the reality is that currently various financial levers are going to be pulled to try to stimulate economic activity – or, at least, to prevent it from contracting. We have already heard that the Government seems set to abandon its plans to balance its budget by 2020, heralding a loosening of fiscal strategy to support the stimulus provided by lower interest rates.
There is, though, some irony that these developments are occurring at a time that concerns are being expressed about a new surge in the level of household debt. Figures for May show that non-mortgage household debt was 9.9% higher than a year earlier. The total of non-mortgage debt now stands at £184 billion – or around £7000 for each household. Worryingly money owed on credit cards, which is normally a very expensive form of borrowing, accounts for £65 billion of household debt. Lower interest rates are likely to make household debt grow further in the coming months. The prevailing low interest rates may make these debts manageable for most households – but what happens when interest rates eventually start to rise again?
*Martin Upton is Director of the True Potential Centre for the Public Understanding of Finance (True Potential PUFin)

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