Higher interest rates have become a boon for parts of the UK economy, as for the first time in decades, the drawbacks for borrowers have been surpassed by the advantages for savers.
According to the Resolution Foundation, the Bank of England's decision to elevate rates from a historic low of 0.1 percent to a 15-year high of 5.25 percent between December 2021 and August 2023 resulted in a £16 billion income surge for savers.
The foundation’s findings further disclosed that the real income from savings witnessed an impressive £34 billion increase over the same period. This substantial rise surpassed the £18 billion rise in debt interest costs, contributing to three-fifths of all household income growth since the final quarter of 2021.
Historically, when interest rates were raised in 1988, 1996, 2003 and 2006, the overall economic effect was negative. Higher rates usually made people spend less, as the rise in debt payments outweighed the increase in income from savings.
This time, the scenario reversed. The resilience can be attributed to a significant proportion of mortgage borrowers being shielded from rate hikes due to fixed-term deals. Approximately 37 percent of households with mortgages when the central bank initiated the rate hikes in 2021 were on fixed-rate deals that had not yet expired.
The research also indicated that household debt is anticipated to continue its upward trajectory in 2024. Approximately 1.5 million mortgagors are expected to face an average annual increase of £1,800 in mortgage expenses as their fixed-rate deals conclude this year.
Another contributing factor to this economic resilience is attributed to the pandemic lockdowns, during which individuals accumulated higher-than-usual savings. An estimated £200 billion of extra savings were set aside when parts of the economy shut down, creating a financial buffer.
However, not everyone is benefiting equally from these rate hikes. Those with less savings than debts among the younger population are bound to feel the brunt of rising interest rates.
Conversely, older demographics with larger savings and fewer debts will reap the benefits. The income gap between these groups is widening.
"The impact of the unlikely income boost has been very uneven — older, asset-rich households have gained the most, while younger mortgagor households have been hit hard," said Resolution Foundation senior economist Simon Pittaway.
Pittaway also warned that borrowing costs could "reduce" income on savings in the coming year, posing a fresh living standards challenge, especially in an election year.
Modest growth expected
While the Bank of England's record interest rate hike reshaped the economic landscape, the findings also suggest that the income boost for savers may be short-lived, potentially unwinding by the year's end.
However, the UK economy is anticipated to receive a spring boost as inflation falls below the 2.0 percent target. Forecasts by Bloomberg Economics suggest that the Bank of England will cut interest rates, marking the end of the current period of stagnation.
Notably, inflation has declined more rapidly than anticipated. With wholesale gas and electricity prices continuing to fall, UK economists Dan Hanson and Ana Andrade predict "modest, if unspectacular, growth" in the second half of the year.
This improved outlook and declining inflation allow the BoE to ease rates, with expectations of a quarter-point rate cut from 5.25 percent in May and a further reduction to 4 percent by the end of the year.
"A soft landing remains our base case," Deutsche Bank senior economist Sanjay Raja noted.