Interest Rates Look Set To Remain Low

24.08.11

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Hands up anyone who thought, back when the Bank of England cut its interest rate to 0.5% in March 2009, that it would remain 0.5% for over two and a half years? I think most of us ex

Hands up anyone who thought, back when the Bank of England cut its interest rate to 0.5% in March 2009, that it would remain 0.5% for over two and a half years? I think most of us expected rates to have improved by now, but although savers had some false hope along the way, the rate remains steadfastly firm at 0.5% and forecasts for the first increase keep getting pushed further and further away. Inflation is also above target so many cash savers are earning negative rates of return. Anyone who needs their savings to generate an income should consider alternatives to bank accounts.

The Bank of England?s (BoE) last Monetary Policy Committee (MPC) meeting was held on 4th August and the minutes released on 17thAugust.

While the decision was hardly a surprise to anyone, the bad news for savers is that the decision was unanimous – the two members who had previously been calling for a rise stopped doing so, accepting that the Bank cannot increase the rate at the moment.

It now appears that the Sterling interest rate could remain on hold into next year or even later.

A Reuters? poll of leading economists on 17th August predicted we will have to wait till next October for the first rise. Just a week earlier they had said it would be between July and September.

?With modest growth, downside risks and major uncertainties, the MPC will continue to err on the side of an overly loose policy stance rather than risk overly rapid tightening?, said Michael Saunders, economist at Citi.

Although earlier this year money markets had indicated a rise could be imminent, they are now pricing in the rise in 2013 or even 2014.

Samuel Tombs at Capital Economics warned the BoE rate could remain at 0.5% until the end of 2013. It?s worth paying attention to what Capital Economics forecasts because they are one of the few firms who predicted rates would still be low today. In June 2009 its founder Roger Bootle said he thought ?interest rates could be kept at their record lows for as long as five years? and although that may have been considered overly negative at the time, it looks increasingly like he was right.

The MPC meeting also raised the prospect of another round of quantitative easing (QE), which is where the Bank buys bonds to pump cash into the economy. The programme was launched in early 2009 and last used in early 2010. While some members suggested the bank should buy bonds immediately to aid the struggling economy, the committee has left the door open on the possibility ?were some of the downside risks to materialise.?

Interest rates tend to rise when inflation goes up, but the UK continues to be in the unusual situation of having high inflation without much prospect of an interest rate rise.

The Consumer Price Index (CPI) rose from 4.2% to 4.4% in July, higher than expected. It included the biggest increase in clothes prices since 1997.

UK inflation has been above the 2% target for over a year and a half, thanks largely to global commodity prices, the VAT increase and a weak Pound. Governor Mervyn King has warned that could hit 5% this year, but he does expect it to retreat next year.

The BoE is expected to continue to disregard inflation when it comes to setting interest rates. Inflation has not carried through into higher wage demands and the risk of impeding economic recovery by imposing a higher interest rate are greater than the inflation risks.

For cash savers, however, high inflation makes the interest rate situation even worse. To quote Michelle Slade of Moneyfacts, this latest cost of living increase will ?continue to antagonise savers, leaving them very few options to negate the effects of tax and inflation?.

With inflation at 4.4%, basic rate taxpayers have to find a savings account paying 5.5% interest per annum to beat inflation and higher rate taxpayers need 7.33%. However, there are only eight accounts that currently beat the effects of tax and inflation for basic rate taxpayers. Most savers therefore are earning negative real rates of return.

Inflation in most of Europe is better than the UK, but still higher than it should be. The average rate this year for the EU as whole is 3%, while it is 3.6% in Cyprus and Portugal, 3.2% in Spain, 2.7% in Malta and 2.1% in France. The European Central Bank?s (ECB) target is close to, but below, 2%.

Even low inflation will have a negative impact on your spending power over time.

While the US Federal Reserve Bank (Fed) has said it will hold rates near zero for at least two years, the ECB often takes a different stance than the Fed and BoE. It has already raised its interest rate twice this year, taking it to 1.5%, but markets are now wondering if it will have to reverse that decision ? which is what happened after it raised rates at the beginning of the credit crunch.

The ECB however tends to give priority to its inflation fighting mandate, so it is possible it will not lower its rate. However it does look like any chance of another rise this year is now off the cards.

Even when rates do start to rise, it is likely it will be a gradual increase and it may be years before rates are back to what used to be considered normal. If you will not accept such a low level of income from your savings any more, speak to a wealth manager like Blevins Franks to discuss your alternatives.

By Bill Blevins, Managing Director, Blevins Franks

18th August 2011

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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