Why rising interest rates may not protect your clients’ wealth from inflation

In February 2023, the Bank of England (BoE) increased its interest rate to 4%, as it continues its fight to bring inflation in the UK down. It was the tenth increase in a row since December 2021, and may not be the last, the Guardian has revealed.

It reported warnings from a key policymaker at the central bank that rates may need to rise further to stop higher levels of inflation becoming “entrenched” in Britain’s economy. It’s likely to be depressing news for the millions of homeowners with certain kinds of mortgage, such as a standard variable rate (SVR) or tracker mortgage. 

This is because they typically follow the BoE’s interest rates, so if you have clients with these types of mortgage, they are likely to see their monthly repayments rise further. That said, if your clients have money in savings accounts, they may welcome the idea of higher rates after years of earning historically low interest.

While higher interest rates may sound like good news on the face of it, your client’s wealth may still be at risk from inflation, and could drop in value in real terms. Before you read on to find out why this is, let’s look at why interest rates typically rise when inflation does.

Historically, interest rates have been used to control inflation

Inflation is the increasing price of goods and services over time, which means that £1 is likely to buy you more today than it will in the future. To demonstrate this you might want to consider the following. 

If you use an inflation calculator you can see that you would have needed £204 in January 2023 to have the same spending power of £100 in January 2003. This means that your money would need to increase by 104% during the 20-year period to keep pace with an average inflation rate of 3.6% a year. 

This is significantly lower than December 2022’s rate of inflation, which the Office for National Statistics revealed was 10.5%. While low levels of inflation are seen as a sign of a healthy economy, if it becomes too high it has the potential to impede on economic growth as the cost of raw materials, goods and services soars. 

Raising interest rates tackles a key driver of inflation

Historically, governments have dealt with high inflation by increasing interest rates, as doing so helps to address one of its biggest drivers: consumer demand.  One reason for this is that higher rates increase the cost of debt, which includes mortgage repayments.

This, in turn, means that millions of households have less disposable income to spend on the high street. Another reason increasing interest rates reduces consumer demand is that it encourages people to save their money and not spend it. 

If the latter is something your client is doing, they may not realise that their money could still be affected by inflation, and may result in their wealth decreasing in value in real terms. We will consider this next. 

Inflation could still reduce your client’s wealth in real terms

While the BoE expects inflation to drop to 4%, it doesn’t see it happening until the end of 2023. Furthermore, it does not expect the cost of living to start to fall until the second half of the year.

If your client has money in savings accounts, the interest rate they’re receiving could  be significantly lower than December’s inflation level of 10.5%. This is backed up by Moneyfacts, which shows that on 10 February 2023, the top easy access savings account offered just 3.01%, and the best five-year fixed-rate offered 4.40%. 

While your client may believe that falling inflation and the possibility of more interest rate rises could solve this issue, an article by the Times in February 2023 provides food for thought. It reveals that the top rates of savings accounts being offered by banks haven’t kept up with the BoE’s increases. 

According to the article, in September 2022, not one of the high street banks had passed all of the BoE’s rate rises since December 2021 to customers with easy access accounts. As you can see, even if inflation does tumble later on in 2023, the interest your client receives on their savings may still not keep pace with it. 

Additionally, as inflation is not expected to drop until the second half of 2023, the interest rate your client is receiving could be significantly lower for several months to come.

Investing might help your client inflation-proof their wealth

The good news is that there might be a better way for your client to inflation-proof their money. Historically, the stock market has tended to provide greater growth potential than cash, so your client may want to consider investing their money to inflation-proof it.

Research carried out by Schroders found that between the start of 1952 and the end of May 2022, UK equities returned 11.7% a year on average, compared to 6% a year for cash. This is backed up by the 2019 Barclays Equity Gilt Study, which tracked the nominal performance of £100 invested in cash, bonds or equities between 1899 and 2019.

It found that the original £100 would be worth just over £20,000 in 2019 if it was invested in cash, compared to around £2.7 million if it had been invested in stocks and shares. That said, please remember that past performance is no guarantee of future performance.

Get in touch 

If your client would like to discuss investing to inflation-proof their wealth, please contact us on hello@ardentuk.com or by calling 01904 655 330. We would be happy to discuss it further with you or your client directly.

As an award-winning financial advice company that was a 2022 VouchedFor Top Rated firm, both you and your client can be sure that they will receive excellent advice and a high quality service.

Please note

This blog is for general information only and does not constitute advice. Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change. 

The information is aimed at retail clients only.

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

Get in touch

By talking about your current situation and listening to your aims, we create a personalised plan that will put you on a path to achieving your aspirations.

More articles

22 Mar 2023 News

3 ways cashflow modelling can help your clients plan for a better future

Read more

22 Mar 2023 News

3 powerful reasons holistic financial advice is vital to a wealth strategy

Read more