What to do with your mortgage and savings as inflation heads towards 5%

Inflation is set to climb to almost 5 per cent next year – with big implications for household finances. The Bank of England aims to keep inflation around its 2 per cent target but it currently sits at 3.5 per cent – with most economists expecting it to climb to even higher levels in 2027. Below, we look at how high inflation could reach, and what it means for you. Shorts How high could inflation get? Economists have different views on how high inflation will get in the next year, but almost all expect it to rise. Pantheon Macroeconomics expects it to reach 4.8 per cent at its peak next February and remain above 4 per cent until July. The forecaster says its new prediction, up from 4.6 per cent previously, is “accounting for the latest wholesale oil and natural-gas prices”. These have climbed significantly since the start of the Iran War, which begun earlier this year. Other forecasters also expect increases. RSM UK has said that inflation could reach around 4.5 per cent early next year and expects it to stay above 3 per cent for most of next year. This, it said, is a result of higher energy, food and memory chip price increases making their way through the supply chain. Capital Economics expects a peak of around 4 per cent in January, but says in an adverse scenario, where oil and gas prices are higher than it expects, inflation could peak as high as 5.5 per cent. What does this mean for interest rates? Experts expect that the Bank of England will have to raise interest rates in the coming months, from its current level of 3.75 per cent. RSM UK and Pantheon Macroeconomics both expect a rise in November, and both think a second rise next year is likely. “With inflation likely to significantly exceed 4 per cent in the new year, a second rate hike looks likely in 2027,” says Thomas Pugh, chief economist at RSM UK. Robert Wood, chief UK economist at Pantheon Macroeconomics expects an interest rate hike in February and says he is “close” to forecasting a third hike as well. That would take interest rates to 4.5 per cent, but some financial traders expect even bigger rises – perhaps to 4.75 per cent. What does this mean for your mortgage? More than four in five households in the UK are on fixed mortgage rates. With these mortgages, you agree an interest rate with a lender for a set period of time – usually two or five years – and the interest rate does not change during this time. If you are on a mortgage rate that is fixed for several years, you may be unaffected by rising rates, but if your rate ends or you’re about to buy in the next six months or so, you may be more concerned. Fixed mortgage prices are generally based on something known as swap rates. These follow long-term predictions for where the Bank of England base rate could go in the future. If traders expect rates to go higher and stay there, these fixed mortgage prices increase. Fixed mortgages are on average around 6 per cent at the moment and experts say that people should not expect them to drop in the near future. “At the moment fears around inflation is driving ever higher mortgage pricing. “And this fear is stemming from one thing – the disastrous and ongoing conflict in the Middle East which is now seeing oil topping $115 a barrel with the belief that with winter looming and demand soaring, it will go higher still,” said Peter Stimson, director of mortgages at lender Mpowered. He added: “Don’t bank on mortgage rates going significantly downwards in the next six months or so – unless we get a surprise resolution to the situation in the Middle East.” Generally, mortgage experts say that if you’re deal is ending soon, you should approach a broker or lenders to lock in a new rate. Most lenders let people lock in a rate around three or four months before their current one expires, and then if rates get better they can move to a cheaper deal. If they get more expensive, they have their agreed deal as a back-up. Some borrowers opt to go on tracker or variable rates temporarily at the end of their mortgage term. These go up or down depending on what happens to the Bank of England base rate, and some people get them when fixed rates are high, planning to move to a cheaper deal once rates fall. But experts sound a word of caution on this. Nick Mendes, mortgage technical manager at John Charcol brokers said: “Borrowers on trackers waiting for rates to fall before they fix are taking a risk in the short-term. A tracker moves with the bank rate, so a high inflation reading in February could add to the pressure for an increase before any cuts arrive. “Fixed rates could also move higher if markets react badly to inflation data, so the gap between a tracker and a fix may not close in the borrower’s favour. “The advantage many trackers offer is flexibility, as most mainstream trackers come with no early repayment charges, allowing borrowers to switch to a fixed rate at any point. That flexibility only has value if borrowers keep a close eye on the market and are ready to act quickly if fixed rates start to rise.” What does this mean for savings rates? High inflation erodes the value of savings as it erodes the value of money held in cash. If prices are rising by 4.8 per cent, savings need to earn at least 4.8 per cent in interest on their cash to maintain the same buying power. If people have easy-access savings – which can be withdrawn from with no penalty – they can try and shop around and move their money to accounts with better rates. Another option is to fix your money. Some accounts give you a set interest rate for a pre-agreed period of time – the best pay above 5 per cent – though you generally can’t withdraw your cash from them if inflation rises. The good news is if the Bank of England does increase interest rates, savings rates may improve. Adam French, head of consumer finance at Moneyfacts, said: “If inflation looks to be persistent, the Bank could raise the base rate further, potentially giving savings rates another boost. Markets are currently pricing in the possibility of the base rate reaching 4.75 per cent.” Analysis of Moneyfacts’ historical rates data suggests the average savings rate tends to settle around 0.5 percentage points below the base rate. If this holds, average savings rates could rise by around 0.5 percentage points from current levels, with some of the best-paying fixed-rate accounts potentially approaching 6 per cent. French warned against people leaving their money in poor accounts. “Those who leave their money in lower-paying accounts could lose out, particularly if providers are slow to increase rates,” he said.