On 2nd of August the Monetary Policy Committee (MPC), voted to increase interest rates to 0.75% – rising by 25bps, as per our forecasts. This makes interest rates the highest they have been in nearly a decade.
The MPC perceive that the economy is strong enough to withstand a rise, the first move higher than the emergency level of 0.5%, introduced immediately following the financial crisis.
Today, unemployment is at exceptionally low levels, and competition for employees should drive a gentle acceleration of wage growth. An upward trend in productivity is also expected to emerge, which would allow firms to increase their pay. The MPC feels it is prudent to raise rates now to constrain these developing domestic cost pressures.
From here, it is expected that future increases in interest rates are likely to be at a gradual pace and to a limited extent, in proportion to the mild projected path for productivity and wages. Furthermore, the latest inflation report highlighted that the contribution of external pressures, namely a rise in import costs related to sterling’s depreciation, is now easing.
“Experian’s central macroeconomic forecast for the UK continues to be predicated on a steady rise in base rate to 1.5% by the end of 2020. We will continue to monitor movements in pay growth, and if the upward trend falters as it has in recent months, a yet more modest path for rates could emerge. Brexit-related uncertainty also presents an ongoing risk to the outlook both to the upside and downside, and the MPC has not ruled out a rate cut if economic conditions should deteriorate.”
While there are some encouraging signs that the economy is strengthening, the squeeze on household incomes remains a key concern. It is important, therefore that households receive the help they require to have positive financial futures. This is where the link between the economy and risk can add value.
Inevitably rate changes have varying impacts on household finances. Savers will receive a better return on their deposits. However, for some, mortgage payments will increase. This would be particularly pertinent for the ‘squeezed middle’.
“There’s no doubt that current macroeconomic situation, particularly inflation outstripping income growth, is testing the resilience of people’s financial positions up and down the country – and yesterday’s announcement will likely start to impact some. At times like this, it is even more important that people understand and monitor their financial position and seek opportunities to improve or at least protect their finances.”
As noted in my previous blog, interest rate rises are one thing: it isn’t necessarily how much they rise, it is how quickly they continue to.
We have always believed that the use of economic variables in risk-based decisions, for example, affordability and creditworthiness, is an effective approach. Adding these metrics to scorecards, for example, can help you to ascertain a person’s likelihood to afford the finance should any economic change occur, as it has.
Scorecards are based on information obtained at a set period, which can become problematic as time passes. First, the economy may have changed, so the variables in a scoring model might no longer behave in the same way that they did at that point in time. Even in a relatively benign economic environment, a business and its strategies will change. Equally how people consume credit has changed – no longer do people prioritise a visit to a branch, but expect instant access via a device or internet. Finally, the consumption of credit has changed. Therefore, the weightings of different pieces of information used in historical scoring models may no longer be as good as they could be.
The economy is interchangeable, so it may not be appropriate to factor in economic data if you’re offering a short-term loan. For a mortgage lender, or someone offering a larger loan over a longer period, fluctuations in interest rates could impact a customers’ ability to pay, making economic data a useful addition. Today, with more people opting for high-value personal loans and car finance, there’s an immediate need to consider the long-term impact of borrowing and ensure credit can be maintained.
In addition to the ongoing analysis of the economy, through scoring and scorecards, understanding the impact of interest rate rises is also a beneficial task. This can be done on a customer or portfolio level, and we see many businesses striving to understand this more and more. Rate rise impact is not only relevant for mortgage lenders but crosses a wide range of markets, including Retail Finance, Telecommunications, Financial Service providers and Commercial Lenders
- What will be the impact of rising interest rates?
- What if interest rates rise sooner or significantly faster than currently anticipated?
- For mortgage lenders, would the interest rate rise be offset by increased losses in certain segments of the customer base?
- Additionally, how can mortgage lenders ensure they meet the MMR (Mortgage Market Review) requirements to stress test the impact of interest rate rises appropriately?
- What impact would this have on current customer product offers and their suitability?
All the above issues are likely to impact affordability, customers’ financial stability and purge changes into business portfolios as the interest rate rises come to fruition – is your organisation prepared for the changes? Are you asking yourself and your portfolio these questions?
At Experian, we offer services to help understand your portfolio at a customer level – with a future view. We can look at the different scenarios and identify the most vulnerable accounts or concentrations. Most importantly we can help you understand the potential impact before it is seen, helping you to maintain your customers and better respond and prepare.