Can we cope with the base rate rising?

Two months and no base rate cut. Not surprising I suppose as now we’re at 0.5% there’s not exactly anywhere for rates to go. Yet it’s the long term that’s more concerning, as we adapt to this low interest rate, low inflation (or even deflationary) environment, the shock once rates return even just back to where they were a year ago could be a problem…

It won’t be quick

Rates are unlikely to move for the moment.

  • Not much room to drop rates.
  • Economic stimulus still needed so rates aren’t going up.
  • A need for stability.
  • We’ve switched to printing money (or ‘quantitative easing’ to dress it in its official disguise.)
  • There’s a need to wait and see if quantative easing is working.

Add to that the Bank of England’s latest inflation report, which assumes that base rates will still be 0.5% into 2010, and economists have read as a strong signal moves aren’t planned for a while yet.

Of course the only certain thing in the current climate is the uncertainty, and there’s the question of still-high CPI inflation, but on the balance of probability it seems the most likely path.

Can we cope with base rate rises?

So for me the big question right now isn’t ‘will we stay at this current interest rate’, but once we move (in maybe up to a year at a guess), assuming it’s upwards, how quickly will rates rise again?

Let’s suppose inflation’s bubbling at the extreme and we see a mirror image of the 5% cut in just a few months. That’ll leave those sitting on SVR or tracker rate mortgages back to where they were eight months ago.

The mortgage elastic only stretches one way.

There’s a funny thing about price rises after price cuts… the feel-bad factor of the rise is not proportionate to the cut’s feel-good factor. In other words, the rise is much worse than that cut was good.

Suppose someone was paying £1,000 a month on a mortgage and it dropped rapidly to £500, then returned six months later to £1,000. Most people’s psychology will mean that paying £1,000 again feels much more expensive than the first time. This is partly due to what I call “forgotten gold”.

Usually this happens the other way, when people get a pay rise. You were earning £25,000 a year, then it’s £30,000 but very quickly you adapt and stop enjoying the new salary rise as spending increases to take account of the new income and expectations. It’s the reason why if you want to put part of your new salary aside, do it by standing order the very FIRST month the payrise starts… after even a couple of months you’ll find yourself saving less as you don’t want to forgo the benefit.

Much of this is true with the mortgage scenario, tracker holders have adapted to having the extra cash. Those who are simply saving it in a high interest account won’t be hit too hard, but those who are spending it each month will feel the pain.

And that’s the problem, people are bad at cutting back, and over the last ten years far too many have learned to rely on debt to fill the gap (see stop spending guide). Not what you need when rates are jumping.

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