When the Bank of England voted to keep interest rates on hold at their March monetary policy meeting, it marked three years since the rate was reduced to the historical low of 0.5%.
When the Bank of England voted to keep interest rates on hold at their March monetary policy meeting, it marked three years since the rate was reduced to the historical low of 0.5%. We have now entered a fourth year of rock bottom interest rates, and there is still no light at the end of the tunnel for savers.
Savers will be very disheartened to hear that the respected economics consultancy firm Capital Economics have warned that interest rates will probably remain at record lows for another three years.
Vicky Redwood, the consultancy's chief UK economist said that the combination of prolonged fiscal consolidation, sluggish economy recovery and weak bank lending could mean that the Bank of England (BoE) has to keep rates at 0.5% until 2015.
“We would not be surprised if interest rates stayed at their current level for another three years and even in sticking at these low levels it may not be enough to generate a strong recovery, especially with higher bank funding costs prompting a rise in some mortgage rates.“
Redwood even suggested that official rates could potentially fall even further to 0.25%.
When the interest was first cut to 0.5% in March 2009 few would have expected the rate to be unchanged three years later. The expectation then in the City was that the move would be short-lived and rates would start rising in early 2010 and to be back at 3% by 2012.
In contrast to this view, in June 2009 Capital Economics? founder and managing director Roger Bootle said he thought ?interest rates could be kept at their record lows for as long as five years?. Redwood now says that they had “thought that interest rates would need to stay low in response to a prolonged fiscal consolidation, weak bank lending and a sluggish economic recovery, all of which we have seen.”
Capital Economics, as well as other analysts, also expect the Bank of England to announce another round of quantitative easing (QE) later this year. The QE programme has already been increased by ?50 billion in February, following a ?75 billion boost last October, taking the total to ?325 billion.
BoE studies have concluded that although QE is inflationary, the programme has boosted economic growth and confidence in the economy.
Savers and retirees
Savers and retired people have, many consider unfairly, been the ones who suffer most from the Bank?s stimulus measures.
The UK campaign group Save our Savers have complained that the low interest rate have placed a ?grossly unfair and disproportionate burden? on savers and retirees, adding that it is ?an extraordinary and monstrously unjust transfer of wealth from savers and pensioners?.
The National Association of Pension Funds also used the anniversary of the rate cut to highlight that the impact of QE on pensions has been worse than expected. It reduces gilt yields and so lowers annuity rates for retirees. It said that the downward pressure on gilt yields from the Bank?s latest round of buying bonds under QE has pushed final salary pension funds another ?90 billion into the red.
A market analyst at BGC Partners, Louise Cooper, described savers as being ?crushed?. The 0.5% interest rate has cost savers ?76 billion over the last three years when compared with the previous three years which had higher interest rates.
According to BoE?s own figures, over ?100 billion is sitting in bank accounts which are not paying any interest. In the years before the financial crisis the amount was much lower at between ?15 billion and ?20 billion.
BoE governor Mervyn King, has said he understands the problems facing savers and is sympathetic, but insists there is nothing he can do to help as the measures are necessary to help the economy. In February he told a press conference:
?I have deep sympathy with those who are totally unconnected with the origins of the financial crisis who suddenly find that the returns on their savings have reached negligible levels. These are consequences of the painful adjustment prompted by the financial crisis and the need to rebalance our economy.”
He said that putting the interest rate up to 4% or 5% would push up the exchange rate, depress investment and consumer spending, result in more people losing their jobs and cut the value of assets on which many savers depend.
?All groups in society are suffering from the financial crisis,? he said. ?Difficult though it is, we have to make a difficult judgement about the right course of action for the economy as a whole.?
The situation is not much better in Europe. The European Central Bank (ECB) also left its interest rate unchanged at 1% at its March meeting. Although it had prematurely raised its rate to 1.5% last year, it then made two consecutive cuts towards the end of the year which brought it back down to 1%.
The ECB is now expecting the Eurozone economy to shrink by 0.1% this year. While analysts do not expect the key rates to be cut any further for the time being, there is not really any hope that interest rates will go up any time soon.
Savers need to consider the impact of taxation and inflation on their already negligible returns. Many are earning negative real returns which means the spending power of their savings is being weakened. This is particularly dangerous for retired people who do not have new capital coming in.
If you would like to consider your options for income or capital growth, and have peace of mind that your investment strategy has the objectives of keeping pace with inflation and not losing any more income to tax than you have to, speak to an experienced wealth manager such as Blevins Franks.
By Bill Blevins, Managing Director, Blevins Franks
15th March 2012