Impact on Markets, Pensions and Life When Interest Rates Rise and Fall
Published / Last Updated on 18/12/2025
The Bank of England reduced central bank interest rates to 3.75% pa on 18th December 2025, its lowest pint since 2023 after a long period of higher interest rates fighting the cost of living crisis and the extended period of higher inflation.
What Happens When Interest Rates Rise?
Property
- Mortgage borrowing costs increase (unless you are locked into a lower fixed rate), you should always plan for higher interest rates by overpaying on your mortgage to get used to higher payments for when rates rise.
- Property rents may increase as landlords’ costs increase with some of those inevitably being passed on to tenants.
- Property prices may stagnate or fall as borrowers can afford to borrow less as mortgage payments are higher.
- Stamp duty costs may fall if property prices fall meaning less costs to the purchaser but also less revenue for the Treasury.
Savings
- Savings interest rates should rise so you should earn more interest.
- More interest means potentially more income taxes to pay (income taxes on savings interest are currently set at your highest rate of income tax i.e. 20%, 40%, 45%) after any saving allowance but the savings rates of income tax increase in April 2027 by 2%, so more tax to pay. All this means more income tax revenue for the Treasury.
- To avoid tax, move as much cash savings into Cash ISAs if you can.
- Inflation is key here: If your savings rate is beating the current inflation rate then you are gaining value but if your savings rate is lower than inflation, your money is devaluing and you may wish to consider alternative investments for income.
Government Borrowing/Gilts/Bonds/Fixed Interest and Index Linked Funds
- If central bank interest rates increase, then government borrowing costs will increase. Why would you or your pension fund lend money to the government (gilts) if the rate they were paying was lower than you could get in the bank?
- The government therefore must pay more on its debt interest rate (gilt yield) meaning more taxes may be needed or government spending may be cut.
- An increase in gilt yields will push the capital value on existing gilts (in the repo market) down and also the capital value of your fixed interest and index linked funds down in your pension fund, stock ISA, insurance bond investments.
Annuities
- Increased government gilt interest (gilt yields) affects annuity rates.
- Think of gilts like an interest only mortgage. The government borrows money at an agreed rate of interest payable each year and at the end of the term it must repay the loan back to the lender e.g., a pension fund.
- A pension company takes your pension fund, lends it to the government in the form of gilts, receives a guaranteed interest payment (coupon) that is payable over the loan term, and that guaranteed income allows the pension company to pay you a guaranteed annuity income, usually for life or a fixed term. If gilt yields (government interest rates) are higher, then annuity rates are higher.
Business & Economy
- When interest rates rise, the costs on business rise as well as the costs to consumers rise meaning, prices may rise and the economy slows down.
What Happens When Interest Rates Rise?
The Reverse of the Above ….
Property
- Mortgage borrowing costs reduce (unless you are locked into a lower fixed rate), you should always try to keep paying the old, higher amount to repay your mortgage faster and to remain used to higher payments for when rates rise again.
- Property rents may remain unchanged.
- Property prices may increase as borrowers can afford to borrow more as mortgage payments are lower.
- Stamp duty costs may increase if property prices increase meaning increased costs to the purchaser but also more revenue for the Treasury.
Savings
- Savings interest rates should fall so you should earn less interest.
- Less interest means potentially less income taxes to pay (income taxes on savings interest are currently set at your highest rate of income tax i.e. 20%, 40%, 45%) after any saving allowance but the savings rates of income tax increase in April 2027 by 2%, so more tax to pay anyway. All this means more income tax revenue for the Treasury.
- To avoid tax, move as much cash savings into Cash ISAs if you can.
- Inflation is key here: A rate reduction is the key time to check what your new interest rate will be. If your savings rate is beating the current inflation rate then you are gaining value but if your savings rate is lower than inflation, your money is devaluing and you may wish to consider alternative investments for income.
Government Borrowing/Gilts/Bonds/Fixed Interest and Index Linked Funds
- When central bank interest rates reduce, then government borrowing costs will reduce. Why the government pay more in interest (gilt yields) on borrowing if you or your pension fund would earn less in the bank.
- The government will pay less on its debt interest rate (gilt yield) meaning less taxes may be needed or government spending may be increased.
- A reduction in gilt yields will push the capital value on existing gilts (in the repo market) up and also the capital value of your fixed interest and index linked funds up in your pension fund, stock ISA, insurance bond investments.
Annuities
- Reduced government gilt interest (gilt yields) affects annuity rates.
- As per the above explanation when interest rates rise, if gilt yields (government interest rates) are lower, then annuity rates will fall.
Business & Economy
- When interest rates fall, the costs on business fall as well as the costs to consumers fall meaning, prices may fall and the economy recovers.
