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Why does the US rate rise matter to the UK?

US interest rates have risen by 0.25% due to the fact that the US has recovered substantially from the great recession. Policy makers now believe that homeowners and businesses are strong enough to absorb an interest rate rise.

Some say that when America sneezes, the rest of the world catches a cold. So will UK interest rates rise as a result of the rise in the US? And if so, what would the effect be on the man in the street?

The rate rise in the US signals the end of the low interest era that has dominated the world economy since the financial crisis in 2008, when the US dropped rates to zero and kept them there. The UK followed suit and dropped rates to 0.5%. They have stayed frozen ever since. Interest rates do need to rise and the sooner the better because waiting too long would see sharper, more uncomfortable rate rises.

Sterling & Law’s chief economist explains: “The UK probably won’t be that far behind the US – we still expect UK rates to start rising in the second quarter of 2016, which would only be a few months behind the US. But we expect US rates to increase at a quicker pace than those in the UK; we expect rates in the US to end 2017 at 3.5 per cent, compared to just 1.5 per cent in the UK.”

So what are the consequences for us when rates do rise in the UK?

  1. Increase in the cost of borrowing. Interest payments on credit cards and loans would be more expensive. This would discourage people from borrowing. People who already have loans could find them more expensive ending up with less disposable income.
  1. Increase in mortgage repayments. This would have a big impact on consumer spending. This is because a 1% increase in interest rates would increase the cost of a £300,000 mortgage by £250 per month.
  1. Good news for savers.Higher interest rates would make it more attractive to save in a deposit account because of the interest gained.
  1. Stronger pound:A stronger Pound makes UK exports less competitive – reducing exports and increasing imports. This has the effect of reducing demand in the economy.
  1. Increased pressure on Government borrowing.The UK currently pays over £23bn a year on its own national debt. Higher interest rates increase the cost of government interest payments. This could lead to higher taxes in the future.
  1. Reduced confidence. Interest rates have an effect on consumer and business confidence. A rise in interest rates discourages investment; it makes firms and consumers less willing to take out risky investments and purchases.

So what should you do? Now is a good time to review your finances. Consider what borrowings you have and how you would be affected if the interest rate increased. Is it worth considering a fixed rate on your mortgage, for example? Speak to your Independent Financial Adviser and plan ahead. The US has sneezed. Don’t catch a cold.

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