What effect will the rate hike have on savings?

It was forecast to happen, and this time the forecasters were spot on. The Bank of England has increased interest rates by another quarter point in July, to 5.75%. This interest rate level has not been since March 2001.

It was only twelve months ago that interest rates were down at 4.5%, and it is four years since they were at the now scarcely-believable level of 3.5%. The last year has seen hundreds of pounds added to outgoings of householders.

Many families are already riding the tide of debt and another increase in mortgage repayments is going to hit them hard. For an average £200,000 loan, there will be another rise in payments of £33 to add to the £127 lumped on them since August 2006.

Waiting in the wings, wondering how much agony they’re going to face, are over a million homeowners with fixed rate deals from two and three years ago which are around the 4-4.5% level. These people will soon have to look for a new mortgage deal and they are going to be faced with rates of over 7.5% if they allow themselves to fall back on to the lender’s standard variable rate (SVR). That could mean an increase of a shattering £215 per month. Even if they take the sensible course and look for a deal, they are looking at two-year fixed rates of 5.5% and a rise of nearly £100 per month, plus annoying fees on top.

Unlike these people, savers will be happy enough with the rate rise. Usually providers are slow to pass on the rate to their savers. Icesave announced that it will pass on the full 0.25% to its customers, with an interest rate of 6.2%.

For borrowers, that will come as not comfort. Mortgages have been changing in the last couple of weeks in anticipation of the rise, coming as it did after weeks of forecasts and warnings from those on the Monetary Policy Committee itself. Providers will not be slow in passing on even mort mortgage misery to their customers.

The question now is: will rates be pushed up again? Many experts think the answer is yes. A rate of 6% has been forecast for at least the last two months, and Mervyn King, unhappy at the rate being held at 5.5% in June, warned that doing so might mean a higher peak would be needed in the future. That sounded like a thinly veiled promise of 6% soon enough.

The Bank has been battling to keep inflation and house prices under control, and there were only real signs that they have started to do this since the last rate rise in May, but they didn’t come soon enough to head off July’s rise.

The government’s measure of inflation (Consumer Price Index: CPI) reached 3.1% in March and was down to 2.5% in the most recent figures. This is still, however, above the target of 2%, and the MPC may still feel that more action will be needed. Lower gas and electricity prices may help CPI fall again soon. The MPC said: “Although pay pressures remain muted, the margin of spare capacity in businesses appears limited and most indicators of pricing pressure remain elevated. The committee judged that, relative to the 2% target, the balance of risks to the outlook for inflation in the medium term continued to lie to the upside. Against that background, it further judged that an increase in Bank Rate of 0.25 percentage points to 5.75% was necessary to meet the 2% target for CPI inflation in the medium term.”

Higher rates have begun to have an impact on the housing market. Britain’s largest mortgage lender, the Halifax, has reported that house price inflation has been under 0.5% for the last two months, much less than the first quarter of the year or the last quarter of 2006.

The rate rise will be frustrating to new Prime Minister Gordon Brown and his new Chancellor Alistair Darling, coming as it does so early into their new roles. Mr Brown spent much of his time as Chancellor telling us how prudent he was and how well his policies were working. He might have to change his tune if rates hit 6%, as that was the level they were at when Labour came to power in 1997.

The UK’s debt problem is looking increasingly weighty as interest rates continue upwards. Recent reports suggest that 19% of an average household’s income goes towards paying debts – that’s a record figure and beats that of 1990 when interest rates stood at 15%.

The interest rate rise of late, coupled with a weak US dollar, have served to take the pound to its highest level for 26 years, above $2. The dollar has also suffered against a strengthening Euro.

Last month the European Central bank increased its interest rates to 4%, but experts believe that the ECB will leave them unchanged for a couple more months.