Another Three Years Of Low Sterling Interest Rates

The Bank of England unveiled a new policy which means interest rates are expected to remain at historical lows for another three years.

In another blow for savers, the Bank of England unveiled a new policy which means interest rates are expected to remain at historical lows for another three years. Besides UK savers, this also affects the many British expatriates who keep savings in Sterling.

As part of its new “forward guidance” approach, Bank of England (BoE) Governor, Mark Carney, announced plans to maintain “exceptional” stimulus efforts, including the 0.5% base interest rate and quantitative easing, until the rate of unemployment falls to 7%. The Banks’s forecasts suggest that this will not happen until the last quarter of 2016.

With unemployment currently 7.8%, around 750,000 new jobs may have to be created before rates rise.

This three year period is not set in stone.  There are caveats, mainly in relation to inflation, whereby the Bank could increase interest rates even if unemployment remains above 7%.  Mr Carney explained that the forward guidance is not a promise, but rather sets out the conditions that would need to be met for the Bank to consider increasing its base rate.

The guidance does not necessarily mean that rates will rise in three years’ time either.  The 7% unemployment threshold is merely a way station at which point the Bank will reassess the economy and appropriate stance of monetary policy.   The Governor has pointed out that 7% is still unacceptably high, so the BoE may issue more guidance at that point, rather than automatically increase the rate.

It may also take longer than the Bank expects.  In March the Office for Budget Responsibility forecast that unemployment would stay above 7% until 2017.

Mr Carney took over as the Governor in July and immediately began to manage interest rate expectations by providing more explicit guidance to the markets and public.

At the BoE’s Quarterly Inflation Report press conference on 7^th August, he said that although the UK was at the start of a renewed recovery it was the weakest on record, so the Monetary Policy Committee needs to make further progress.   This is exactly the time when it needs to provide greater clarity about how it would react to underlying economic conditions and set monetary policy.

The aim of this guidance is to reassure homeowners and businesses that interest rates will remain low for some time.

Business associations reacted positively, calling the strategy “reassuring” and “bold and imaginative”.  Chancellor George Osborne welcomed the decision, saying it gives hard-working families and businesses greater certainty that rates are going to stay low for longer.  He did not mention savers.

Savings rates

If the base rate does remain unchanged until late 2016, it would have been 0.5% for seven and a half years.  Savers groups attacked the latest decision, with depositors now facing the prospect of losing tens of billions of pounds on top of what they have already lost.

Bank and building society deposit account rates are often higher than the 0.5% base rate.  However they have been depressed by the Government’s Funding for Lending scheme which provides cheap cash to banks provided they use it to lend more to businesses and homeowners.  Banks are now less reliant on deposits and do not need to offer competitive interest rates.  The scheme is scheduled to run until January 2015 and may be extended.

Editorials in The Telegraph on 29^th and 31^st July reported that savers have already lost £2.6 billion worth of interest since it started.  Interest on one year bonds fell by 41%.    Over the first half of 2013, banks and building societies knocked nearly £850 million off the annual interest paid to savers. 750 cuts were made, compared to 86 in the whole of 2012.

Expatriate savers are also affected.  While offshore banks do not benefit from the scheme, their onshore parent companies might.  As Charlotte Nelson of data analysts Moneyfacts told The Telegraph, since the scheme was launched “not a single savings account – including those offshore – has been untouched by its effect”.

This is a good time to review your savings strategy.  Besides considering interest rates themselves, you also need to consider the effects of inflation and taxation.  Many savers are earning negative real rates of return when inflation is factored in, and yet still have to pay tax on the nominal return.

To preserve your wealth you need to consider investing in assets which will protect the value of capital in real terms over the medium to longer term.  Seek professional wealth management advice on how to improve your return potential, keep pace with inflation and structure your capital to be as tax efficient as possible.

9 August 2013