Just How Low Can Interest Rates Go?

12.08.16

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The Bank of England has made history by cutting the interest rate to 0.25%. How might this affect you and what can you do to future-proof your finances in these uncertain times?

The Bank of England has made history by cutting the interest rate to 0.25%. How might this affect you and what can you do to future-proof your finances in these uncertain times?

This is proving to be an eventful year for the UK. After the unexpected Brexit vote in June, the Bank of England (BoE) has now cut the interest rate to its lowest ever level of 0.25%.

This did not come as a surprise. Before the announcement, interest rates remained at the historic low of 0.5% for more than seven years. There were also strong indications that a vote to leave the EU would disrupt this stalemate and trigger an even lower rate.

As well as reducing the rate, the BoE announced a stimulus package that brings their total ‘quantitative easing’ efforts to boost the economy up to £435 billion. This involves ‘printing’ money to buy £60 billion of UK government bonds. It also pledged to spend £10 billion on a corporate bond-buying scheme.

Why cut already low rates?

Now that the referendum result is sinking in, the BoE is working to reduce Brexit’s negative effects on the British economy.

“Obviously the economy is in a period of uncertainty” said BoE Governor Mark Carney, and is “about to go through a period of adjustment as we move to a new relationship with the European Union.”

This uncertainty has generated “quite considerably” slower growth for the UK economy. In fact, the BoE has made its largest ever adjustment to its growth forecast – reducing the 2.3% for 2017 predicted in May to just 0.8% in August. With Brexit in the picture, it shrunk its growth numbers for 2019 by 2.5% in the space of only three months.

With this latest combination of measures, the BoE is, according to Carney, acting “in a smart way” to prevent Britain heading into a Brexit recession.

How can cutting interest rates help the economy?

Put simply, low interest rates stimulate a weak economy by encouraging more borrowing and spending through cheap credit. Add fresh money from the government bond-buying programme and this results in more money being pumped around the economy in general.

It is usually only when inflation reaches the tipping point of 2% (for the Consumer Price Index) that the BoE will look to dampen growth by increasing the interest rate. With the current inflation rate at just 0.3%, this is unlikely to happen for some time. The opposite is much more likely. Carney confirmed he is prepared to cut interest rates even further although he did add that he is strongly opposed to negative interest rates.

How does this affect your pocket?

The prolonged low interest rate climate is more bad news for savers. Bank deposits that are already earning next to nothing are now set to drop even lower.

Many think saving in a bank is the ‘safest’ way to look after their money but it presents risks that are often overlooked. Besides low returns, money in the bank can be eaten away by inflation over the longer term. If rates fall below zero – as has been the case in Sweden, Denmark, Japan and Switzerland – you could even end up paying the bank to hold your money for you.

This is especially relevant if you are relying on your savings for your retirement income. If you want your savings to keep up your standard of living, you need to maintain your buying power over retirement – and it may be longer than you expect. Even with higher interest rates of around 3%, with the effects of inflation factored in you could find the value of your savings halved within 24 years.

With interest rates close to zero – and few predicting any increase before 2019 – this could have significant implications for your standard of living and the legacy you wish to pass on to your family.

British expatriates also need to consider exchange currency risk in what is currently a highly volatile time for sterling. If you are living in Portugal [Spain/France/Malta/Cyprus/abroad] and spending euros in your daily life, it can become much more expensive to take your income, like your pension, in pounds. It is a good idea to seek advice about investment structures that allow flexibility to choose when you convert your income between sterling and euros.

Future-proof your finances

While low interest rates look set to stay for some time, the pound is unsteady on its feet and no-one is quite sure how the Brexit landscape will unfold.

This is a good time to review how you structure your finances and consider alternative options for investing. A professional adviser can help you establish the savings and investment strategy that suits you best. They should start by taking an objective analysis of your risk appetite, and then build a portfolio to suit your personal circumstances, aims, time horizon and risk profile.

In any scenario, a well-diversified portfolio that spreads interests across different regions, asset types, sectors and currencies will limit your exposure in any one area. This means you will be best placed to ride out this long low of interest rates, as well as currency or market turbulence in these uncertain times.

 Any questions? Ask our financial advisers for help

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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