It is now perceived wisdom that the only way for interest rates is up. This is despite the original Bank of England policy that QE would be unwound before increasing base rates. That assurance has been quietly dropped.

The issue for most banks and building societies is what action they should take. It has to be said that for the last two years, at least, many institutions have been putting the interests of their borrowers before depositors. There had been a steady reduction in credit interest rates on both existing and new products. The cynic in me might almost think that rates have been dropped so that when base rate increases, this can be passed on in full to savers, but without the impact on full year bottom line and net interest margin that would otherwise have prevailed.

Of course for borrowers, the rates that they pay on their mortgages are predicated on Libor and Swap Rates, not on underlying Bank of England base rate. So what will be passed on?

For those on fixed mortgage rates there will be no difference, until they come to the end of their initial rate period, with all the consequences of potential rate shock and facing the more vaunting post MMR affordability rules. Those on an SVR will probably face an increase but it is likely to be less than the first two 25 basis point increases. I think we will only see as little as 30 of the first 50 point increases passed on.

This continued desire to support the mortgage market is at the expense of their depositors. They will see an increase in savings rates of a similar amount, so maintaining the firm’s net interest margin.

It remains to be seen how the Monetary Policy Committee will view all of this as this is seen as a tool to squeeze inflation out of the economy. But it increases income in the hands of depositors and will not substantially impact borrowers. The bigger impact is on business who need to fund pay increases to keep the merry-go-round alive.

 

Robert Sinclair
September 2015