Could UK Interest Rates Be Cut To Zero?

29.05.12

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The Sterling interest rate has been held at the all time low of 0.5% for over three years, and many savers have been earning negative real rates of return. According to Bank of Engla

The Sterling interest rate has been held at the all time low of 0.5% for over three years, and many savers have been earning negative real rates of return. According to Bank of England figures in March, over ?100 billion was sitting in bank accounts not paying any interest. This compared to levels of ?15 billion and ?20 billion before the financial crisis. Savers have been waiting for rates to improve, but instead the International Monetary Fund has recommended that they are cut lower.

International Monetary Fund director, Christine Lagarde, presented the IMF?s annual assessment of the UK?s economy to the UK Treasury on 22nd May, and called on the Bank of England (BoE) to do more to support the economy.

Lagarde praised the government for steering the UK away from a possible financial crisis in 2010 and making ?substantial progress? towards a more sustainable budgetary position and reducing fiscal risks. However there are still too many uncertainties – the stresses in the Eurozone could affect the UK through many channels; growth is slow and unemployment too high. ?Policies to bolster demand before low growth becomes entrenched are needed?, she said.

The IMF assessed that although monetary stimulus had benefitted the economy, the overall outlook remains weak. It said the BoE needs to take the first steps to help the economy. It urged the Bank to consider cutting interest rates even lower than 0.5% to reduce the cost of borrowing and boost private sector investment. It also recommended extending the quantitative easing (money printing) programme.

Minutes of the BoE?s May monetary policy meeting, which was held before the IMF assessment, now reveal that the committee acknowledge that ?there was a case for injecting further monetary stimulus?.

Since the Bank of England was founded in 1694, the UK base rate has never been 0%. Although even 0.5% was perhaps once unthinkable, 0% is not unprecedented in the developed world. The US Federal Reserve Bank has held US rates at between 0% and 0.25% since December 2008 and plans to keep them near zero until late 2014.

While a cut in UK interest rates is the last thing savers need, others have welcomed the suggestion. A senior economic advisor to the Ernst & Young Item Club, Andrew Goodwin, described cutting interest rates from 0.5% as ?certainly a good place to start?.

?The Fed?s target range is 0.00 to 0.25% and we have always said that ours should be the same,? he said. ?It won?t be the solution on its own, but would certainly send out the right signal.?

Looking ahead to when the BoE base rate will finally improve, on 22nd May interest rate futures on money markets predicted it would be January 2016. These forecasts can change almost day to day, but there does not seem to be any prospect for a rise in the foreseeable future.

The Centre for Economic & Business Research, which has always suggested rates are on hold for the long-term, predicted in January that the base rate would remain 0.5% until 2016. Likewise, on the third anniversary of the cut to 0.5% in March 2009, Capital Economics warned that they would probably remain at record lows for another three years. At the time the consultancy's chief UK economist suggested that official rates could potentially fall even further to 0.25%.

The BoE is not expected to increase its base rate even if inflation remains high. One thing that may make it think again is if there is a trend of pay rises, but this is considered unlikely to happen.

Inflation can have a significant impact on your savings. On 22nd May Moneyfacts.co.uk highlighted the dangers of inflation, saying that inflation has wiped almost 10% of the value of UK savings over the last five years. A ?10,000 deposited five years ago would today have the spending power of just ?9,208, even after interest (based on an average rate), allowing for inflation and 20% tax. The situation would be worse for higher rate taxpayers.

A basic rate UK taxpayer needs to earn 3.75% interest a year to keep pace with rising prices, while those paying 40% tax need 4.99%. However the average no-notice savings account only pays 1.15% interest.

These calculations would be based on the official rate of inflation, but everyone?s personal inflation rate is different, depending on what you spend your money on. 5% inflation can halve the value of capital within 15 years.

It is estimated that there is ?1.8 trillion on deposit in the UK. Expatriates also have savings on deposit earning them little or no interest, or possibly negative real rates of return. To quote Warren Buffet, writing in the New York Times a few years ago, ?Today people who hold cash equivalents feel comfortable. They shouldn?t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value.?

We all want to preserve our wealth, and wealth preservation is about the investment of assets which over the medium to longer term will protect the value of capital in real terms, i.e. after inflation and tax. Speak to an experienced wealth manager like Blevins Franks to discuss wealth preservation strategies for your personal circumstances and objectives.

By Bill Blevins, Blevins Franks Financial Correspondent

24th May 2012

Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices which are subject to change. Tax information has been summarised; individuals should seek personalised advice.

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