Friday , June 21 2024

The Best of Both Worlds? How Higher Interest Rates and A Growing Economy Benefits the Consumer

Already this month, the Bank of England has made headlines twice. First, the Bank chose not to lower interest rates. Next, the UK’s economic growth reached the highest in two years, meaning the UK has emerged from its recession. Andrew Bailey, the Governor of the Bank of England, has stated the economy has turned a corner. Even though inflation has now fallen to 2.3%, given the perceived fragility of the situation and the Bank’s previous reluctance to raise rates, a rate cut in June may still be off the cards.

For a brief moment, UK consumers have the best of both worlds – the ability to save money while the economy is growing.

The Bank’s decision to keep interest rates steady is a good thing for savers. For the last two years, interest rates have been rising and reached their peak in August 2023. Many are predicting interest rates to fall later this year, but due to inflation remaining higher than the Bank of England’s target, interest rates remain high for now.

For anyone entering the job market in the last seventeen years, all they have known is low interest rates. Bank accounts were places to store cash, not earn interest. To earn a return on money, one would have to invest it in the stock market. We have grown up in an era of debt: mortgages to buy ever-rising rising house prices, increasing student loans, and interest-free debt for companies looking to raise capital. Every year of my life so far, the government has run a budget deficit, borrowing money at low interest.

In 2021, this changed. For the first time in decades, the trajectory of ever-falling interest rates reversed. Banks started offering savings accounts with higher and higher interest rates. Earlier this year, I opened a savings account offering 8% interest – an astronomical figure compared to what it was when I was growing up when 2% was considered high.

It was no longer only investing that allowed individuals to earn interest – we could save directly from our bank accounts. Although considered high today, this is historically far more normal. Before 2001, the bank rate had never fallen below 5%. While this period of higher interest rates is likely temporary, by historical standards, it is still very low.

Today, interest is open to everyone. In the UK, 97% of adults own a bank account, compared to 23% who invest in the stock market. Even the poorest in society have bank accounts. Interest allows meagre deposits to accumulate over time, rewarding patience. Since interest rates have begun to rise, the household savings rate has risen to over 10% – almost double its pre-pandemic trend. For as long as individuals can earn a decent rate of return on savings, they will save.

In the long-run, this benefits the economy, as it means that when economic shocks happen, households are more resilient to them. A large part of why the cost-of-living crisis was so damaging was because so many households did not have enough savings to deal with price rises. Inflation hurts the poor in particular, who are forced to spend a greater percentage of their income on consumption. Higher interest rates, as well as lowering inflation, also allows poorer households to save for the future.

With or without interest, individuals will try to save for the future. Now, with higher interest rates, individuals will have more in the future. It means they can spend more today without having to borrow money, confident they will have enough money in the future. With low interest rates, individuals will still want to save money – the difference is that without the interest being paid on their savings, they will have to cut back on even more consumption today to save for their future. The growth of the economy is the first sign this is beginning to happen – if individuals can save more for the future, it frees them up to spend more today.

Many have criticised the Bank of England for not lowering interest rates soon enough, despite inflation still being higher than its target. However, with interest rates currently higher, savers find themselves able save money at a rate greater than inflation. Since the beginning of 2009, less than 10% of the time have interest rates been higher than inflation (18 months out of 183), meaning savers have often been losing in real terms.

The last six months are the exception. Interest rates are higher than inflation, the economy has come out of recession, and growth has rebounded. Granted, this does not benefit everyone equally. Those with significant debts, such as variable-rate mortgages, may find interest on debt greater than interest on savings. However, for the 57% of adults with a savings account, the current state of the economy provides a chance to save seldom seen in the last two decades.

High interest rates democratise savings. Instead of only those with collateral being able to borrow money and invest money, these higher interest rates are open to anyone with a bank account.

This is unlikely to last for long with analysts expecting an interest rate cut in the summer. However, for consumers without significant debts, such as young people who haven’t been able to afford to buy homes, this is an unprecedented chance to save. With the economy growing again, for this brief period of time, these consumers might have the best of both worlds.

About Harry Backhouse

Harry Backhouse is an economist, a writer in the field of progress studies, and a policy commentator with Young Voices UK. His work focuses on British price history and inflation over time.

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