Interest Rates To Stay Low

The Bank of England has a new Governor.  Mark Carney took over from Sir Mervyn King on 1^st July and presided at his first Monetary Policy Committee meeting just four days later.

The Bank of England has a new Governor.  Mark Carney took over from Sir Mervyn King on 1^st July and presided at his first Monetary Policy Committee meeting just four days later. He was previously the Governor of the Bank of Canada.

As expected he made no changes to interest rates and quantitative easing.  However he did take the unusual step of issuing an additional statement to advise that rates will not rise in the near term.  It read:

“The Committee noted that the incoming data over the past couple of months had been broadly consistent with the central outlook for output growth and inflation contained in the May Report. 

“The significant upward movement in market interest rates would, however, weigh on that outlook; in the Committee’s view, the implied rise in the expected future path of Bank Rate was not warranted by the recent developments in the domestic economy.”

Mr Carney also implied that the Bank will provide more “forward guidance” on interest rates in future, a policy he employed in Canada.  He is considered an innovator, so we can expect more changes in the coming months. 

At the end of his tenure, Sir King also warned against raising interest rates.  Homeowners in their 30s and 40s have very high mortgage debts and higher rates would push millions into an “unsustainable” position.  The BoE’s latest quarterly financial stability report also said that borrowers would face “significant distress” and “risks could crystallise” if long-term interest rates rose from their historic lows.

European rates

The European Central Bank (ECB) also held its monetary policy meeting on 4^th July.  In a statement, President Mario Draghi said that interest rates will remain frozen for some time and could even be cut again.

“The governing council expects the key ECB rates to remain at present or lower levels for an extended period of time.”

This approach was a U-turn from the Bank’s previous policy of never pre-committing to interest rates. 

It appears the Bank opted to issue forward guidance after the US Federal Reserve Bank’s suggestion that quantitative easing could be scaled back if economic momentum was maintained had caused volatility in the financial markets.

It is too soon for Europe to reduce stimulus and the ECB and Bank  of England would have wanted to ease fears that they would follow the US.

Sig. Draghi also admitted that the committee had an “extensive discussion” about a possible rate cut.  The Bank cut its main interest rate to 0.5% in May and its deposit rate is currently 0%.  It is keeping an open mind about adopting a negative interest rate in future.  

Investors and savers

Stockmarkets reacted positively to the news that financial stimulus will continue in Europe. The FTSE 100 rose more than 3%, the largest one-day rise since November 2011.   Indices in France, Spain and Italy also rose after the ECB announcement.

In contrast, savers can only expect more pain.  They have already been penalised by over four years of rock bottom interest rates.  When you throw inflation and tax into the mix, many are earning negative real rates of return, which reduces the spending power of their bank deposits.

As Simon Rose of UK campaign group Save Our Savers commented, “there is absolutely no chink of light at all. Just when you think things are their darkest, you realise there is still more gloom to come.”

The UK’s Funding for Lending scheme is making life harder for savers.  It was created to provide banks with cheap finance to stimulate lending.   The side effect has been to depress interest rates for savers to all-time lows.  Since banks have cheap cash available they are less reliant on deposits from private savers and do not need to offer competitive interest rates to attract them.

Keeping too much of your savings in the bank carries risks.  Besides the possibility of institutional failure, inflation erodes its value year after year. The only way to protect the wealth you have accumulated is in ‘real terms’, so you need to take inflation and tax into account and plan accordingly. Speak to an experienced wealth manager like Blevins Franks to discuss your personal objectives and circumstances and determine the most effective strategy for holding your savings.

11th July 2013