When will interest rates go down and what does it all mean for my money?

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Interest rates, combined with inflation, have been at the forefront of investors’ minds over the past 18 months, with a very real impact on our mortgages, savings accounts and investments. Here, we look ahead at what could happen to interest rates in 2024, and what this means for your money.

UK interest rates: the background

In the UK, the Bank of England hiked rates to 5.25% in a bid to tame stubbornly high inflation, which sat at 10.1% in January 2023.

It worked, and the Consumer Price Index (CPI) rate of inflation fell to 3.9% in November 2023, with markets rallying on the prospects for interest rate cuts. However, a shock uptick in inflation to 4% in December and news that the UK has entered recession has thrown a spanner in the works.

While markets are still pricing in rate cuts sooner rather than later, the timing and size of the cuts remain uncertain, and there are worries about ‘higher for longer’ rates.

What does all this mean for your investments?

Although the UK stock market put in a poor performance in 2023, global indices on the whole enjoyed a bullish year as investors jumped the gun and priced in interest rate cuts this year.

Falling rates are broadly positive for equities as it means companies and investors – and therefore the economy - face fewer financial restrictions, but the extent of the benefit will depend on the type of stocks.

Growth companies – such as technology stocks – were hardest hit by rising interest rates, as future earnings were expected to reduce and the shares fell as a result. Value companies fared better, as they produce stronger earnings in the present but are less likely to grow earnings in future, therefore interest rate rises are less of a concern.

Growth stocks will be more immediate winners of rate cuts, and this has already been seen with the rally in the tech sector last year - in particular the ‘Magnificent Seven’ stocks made up of Alphabet, Apple, Amazon Microsoft, Metra, Nvidia, and Tesla. However, value stocks are still looking like good value, trading at 13-times their projected earnings, while growth stocks trade on a multiple of 25-times – with the difference twice as wide as the average of the past 17 years, according to Bloomberg.

Investors don’t need to pick either growth or value, a mixture of both types of stocks will provide diversification regardless of the trajectory of interest rates.

Investors should also not forget about bonds, which are a fixed income investment. Rising rates have been bad for bonds, which pay interest and return a capital amount. The interest paid by bonds – the yield – looks less attractive when rates are higher, and inflation erodes the value of the cash being paid in future, meaning the market will demand a higher return from bonds when rates are high.

Alliance Bernstein head of fixed income Scott DiMaggio said that despite rates expecting to be cut, they will remain elevated before retreating. Inflation is also declining and this combination is ‘nearly ideal’ for bond investors.

“Most of a bond’s return over time comes from its yield. And falling yields – which we expect in the latter half of 2024 – boost bond prices.”

What does this mean for your savings?

After a decade of ultra-low interest rates and paltry savings returns, savers have enjoyed a long-awaited uplift on the interest they receive on their cash. However, cash rates have already started to come down as banks and building societies pre-empt interest rate cuts. Moneyfacts said average returns paid on fixed-rate savings bonds and ISAs recorded the biggest month-on-month rate cuts recorded in over a decade.

The average easy access rate fell to 3.17%, the first fall since September 2021, while the average one-year fixed bond fell for a consecutive month to 5.13%, the biggest month-on-month fall since February 2009, and one-year fixed ISA rates dropped to 4.99%.

Savers aren’t in for an easy time and need to review whether they’re getting the best rate but don’t panic as the cuts in interest rates are likely to be gradual and it’s highly unlikely that we will go back to the historically low rates that a generation of savers has been used to.

What does this all mean for your mortgage

If your mortgage deal came to an end in the past 18 months it’s likely that your mortgage payments are feeling a bit more painful. Rising interest rates push the cost of home loans higher, so does that mean mortgage rates will come down as rates do? The good news is, yes.

There has already been movement in mortgage rates, with 30 lenders slashing the cost of borrowing in the first two weeks of the year.

Moneyfacts data shows two and five-year fixed deals fell for a fifth consecutive month and are now at their lowest level in over six months. The average two and five-year fixed rates are currently 5.93% and 5.55%, respectively - the last time they were below 6% was June 2023. With forecasters optimistic about the path for inflation and interest rates, lenders have pre-empted this by cutting their costs, hoping to kickstart a stagnating property market and attract nervous would-be homeowners and movers.

Lenders want more mortgage business and lowering rates is in their interest so expect to see the cost of mortgages fall further this year.

The year ahead

The Bank has the unenviable task of reining in inflation by increasing the base rate while trying to ensure that high costs of borrowing don’t tip the country into recession. So far it has managed to walk this very fine line, with inflation moving closer to its 2% target and the UK – despite sluggish economic growth – so far, avoiding recession.

It is unclear just how much more the UK economy can take, however, and most analysts believe interest rates have peaked and will soon start to fall. Research firm Capital Economics predicted the Bank will lower the base rate to 3% by the end of 2025, while a Reuters poll showed that investors are betting the Bank will start cutting rates as early as May, with three more cuts over 2024 taking the base rate to 4.25%.

However, the Bank remains less optimistic and its latest monetary policy report states that rates are expected to remain around 5.25% until autumn 2024 and then decline gradually to 4.25% by the end of 2026.

It is also worth noting that the recent pauses in interest rates at 5.25% were pushed through on a six-to-three vote, with three ‘hawks’ in favour of raising the base rate to 5.5% versus the three ‘doves’ who wanted to pause. The split vote, and the instance of some policymakers that the cost of borrowing has further to go, indicates rates may not fall as soon as markets hope.

Bank governor Andrew Bailey has remained tight-lipped as to the path of interest rates, confirming to the Treasury select committee that it was important to return inflation to 2%.

“Price stability and inflation being a target is consistent with and supportive of financial stability,” he says. “So it’s important from a financial stability view that obviously we return inflation to target.”

Economists at Deutsche Bank have predicted that inflation could fall to the target 2% in spring, a view backed up by Oxford Economics, which is forecasting CPI to average 2.1% in 2024, down from its November forecast of 3.1% thanks to steep falls in oil and gas prices and softening prices for services.

Policymakers and economists will also have one eye on the US Federal Reserve – which is the equivalent of the Bank of England – for signs on where interest rates will go. The closely-watched Fed kept its rates on hold in a range of 5.25% and 5.5% at its last meeting but its ‘dot plot’ of rate projections saw policymakers pencil in three 0.25% rate cuts this year, with markets pricing in the first cut in May.