When will interest rates start to fall?

Higher interest rates are good news for cash savers, but they are causing problems for borrowers and squeezing many businesses too. Rob Morgan explores when interest rates could fall.

| 8 min read

What are interest rates and why have they risen?

Interest rates represent the cost of borrowing or the reward for lending or saving. If you’re a borrower, the interest rate is the amount you are charged for borrowing money, shown as a percentage of the total amount of the loan. The higher the percentage, the more you have to pay back for a loan of a given size.

For instance, say you borrow £1,000 from a bank. If this loan has an annual interest rate of 10%, you will have to pay back £1,000 plus 10% interest (£100). So £1,100 is the amount you would owe after one year.

If you are a lender, or you’re a saver (a bank will typically loan out money it holds on deposit) the interest rate represents the return you receive. The higher the lending or savings rate, the more will be paid to you based on the amount loaned or, in the case of savings, the amount in your account.

The interest rates set by institutions depend on lots of things, notably who they are lending to, how risky they are, and how long for. However, they are also driven by the rate of interest set by the Bank of England (BoE) – so called ‘base rate’ – to control inflation. If prices are rising too quickly the bank can raise interest rates to make borrowing more expensive and cool demand, which can help rein them in. Conversely, if price aren’t rising and the economy is in slump, the bank can help stimulate demand by cutting interest rates to make borrowing cheaper.

The battle with inflation

In recent years we’ve seen a huge change in interest rates. They were cut to nearly zero in response to the Covid-19 pandemic when lots of businesses and individuals ran into problems. The BoE also created more money through something called quantitative easing (QE) to help stave off a damaging economic slump.

Combined with several external factors including disrupted supply chains and the higher energy and materials costs owing to Russia’s invasion of Ukraine, it resulted in a high level of demand for a relative scarcity of goods and services, sending prices higher. Consequently, the BoE has increased interest rates rapidly to the current 5.25% to try to stabilise them. It targets inflation of 2% a year, but the level has been far in excess of the that, peaking in October 2022 at 11.1%, a 40-year high, and it remains well above target at 6.7% for September 2023.

Bank of England base rate since 2006

Source: Bank of England

Will interest rates go higher or lower?

The highest interest rates for over 15 years have caused significant hardship for many borrowers who have had little time to adjust. At its meetings in September and November, the BoE held UK interest rates at 5.25%, ending a run of 14 increases from the previous near-zero rates. Does this mean they might start to come back down soon? The answer, we believe, is not for a while.

The good news is inflation is now falling back, aided by the steepest energy price rises of 2022 falling out of the annual calculation. Food costs are also stabilising and factory gate prices for many goods are starting to wane. It’s also thought that with higher interest rates constricting economic activity demand will be curtailed and help keep a lid on price rises.

Yet other areas are proving more stubborn. The rate at which prices for services (hospitality, recreation, personal services etc) are increasing is still very high, which is partly a result of rising wages pushing up labour costs, which in turn is caused by a lack of available staff. Meanwhile, the price of oil, an important component of transport costs alongside many other things, could drive inflation higher if it rises from here, for example due to geopolitical tensions. We believe it is likely to take a prolonged period of higher interest rates to bring the UK’s inflation down, and a further hike cannot be ruled out entirely.

When will interest rates fall?

While we are probably at the high point for rates currently, what is more unclear is when they might start to fall. The main message from the BoE at its November meeting was for households and companies to prepare for a prolonged period of high interest rates. Governor Andrew Bailey has said rates must be, “sufficiently restrictive for sufficiently long”.

The BoE will have to consider the impact it is having on the economy, which could experience a recession owing to the effects of higher borrowing costs and reduced demand. Any significant slowdown in economic growth, and knock-on impact on inflation, might result in it cutting rates sooner.

However, in addition to the short term pressures of rising wages and services inflation, there are more structural trends. The recalibration of supply chains in a less globalised world and more fractured geopolitical climate continues, while the large additional spending programmes to finance the green transition and the replacement of Russian energy add to the potential headaches for central banks. There’s more on these factors in our previous article exploring the challenges of reaching the 2% inflation target.

Overall, we think the 2% target is not likely to come into view until the end of 2024 at the earliest, which means the BoE will need to retain a tight monetary policy throughout next year with perhaps only small interest rate cuts from the present level.

Are interest rates on savings going up?

Savers are enjoying the best interest rates in well over a decade with rates as high as 4.5% on easy-access accounts and 5.75% on fixed-term accounts. Yet with inflation still reducing the spending power of savings it’s important to get every last penny of interest you can. The difference between the best and the worst rates can be more than 3%.

To make the most of the opportunities you’ll need to actively shop around for the best interest rates or, more conveniently, use a savings platform such as Charles Stanley Direct Cash Savings. That way you can help maximise the interest rates you receive and quickly switch to a different savings offer as rates, or your circumstances, change. Superior rates are often found among the smaller banks with lower capacities, so it is common for deals to come and go quickly. A savings platform helps you navigate this fast-changing landscape quickly and easily without the faff of lots of admin.

With expectations that base rate will stay high in the short term, we believe variable and easy access savings rates are set to stay remain elevated. However, the picture could start to change for fixed rate accounts where your money can’t be accessed for a period of time. As the market looks forward to interest rate cuts at some point next year available rates may start to fall back. So if you are contemplating a fixed rate deal it may pay off to decide early rather than delay. You mut ensure this sort of account is right for you before committing though. There is usually no access until the term ends, so they are not suitable for an emergency fund or money you might need before that.

Charles Stanley Direct Cash Savings’ interest rates can change or be removed at any time. Restrictions apply for withdrawals from fixed term or notice products. FSCS compensation limits apply. This service is provided by Bondsmith in partnership with Charles Stanley. Bondsmith is authorised by the Financial Conduct Authority under the Electronic Money Regulations 2011, Firm Reference 955601, for the issuing of electronic money.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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