2010 started with the Bank of England and European Central Bank base interest rates at the historic lows of 0.5% and 1% respectively. Savers would have hoped to see an improvement by the end of y
2010 started with the Bank of England and European Central Bank base interest rates at the historic lows of 0.5% and 1% respectively. Savers would have hoped to see an improvement by the end of year, but not only has this not happened, rates are also expected to remain low for a while yet. Can you afford to put up with such low rates for much longer, especially if you are at risk of earning negative rate of return once tax and inflation is taken into account?
In September 2008 the Bank of England (BoE) base rate was a comparatively healthy 5% but by March 2009 it has been cut all the way down to 0.5%, where is has been stuck now for 22 months. The European Central Bank (ECB) rate was 4.25% until September 2008, reaching its current level of 1% in May 2009.
If the low rates were not enough decimate savers? income, increasing inflation would mean that more and more people find they are not earning any real return from their savings, or possibly even negative returns.
In the UK, David Black of financial analysts Defaqto has warned that savers ?face a near impossible task to earn a real rate of return on their savings?.
Less than a week after the BoE held interest rates again, data from the Office of National Statistics announced that UK inflation, as measured by the Consumer Price Index, increased to 3.3% in November. A sharp jump in the cost of clothing and food was largely to blame, but these are not temporary factors and the current CPI is already considerably above the 2% BoE target.
Moneyfacts spokesperson, Victoria Mayo, said:
?Inflation continues to antagonise prudent savers who are already struggling to achieve a competitive return on their money. Those who rely on savings to supplement their income have been hardest hit, many of whom are pensioners?.
Moneyfacts calculate that a basic rate taxpayer in the UK would need to earn 4.13% from their bank account to earn a positive rate of return after inflation and tax, while those on a 40% tax rate would need to find a bank account paying 5.5% interest.
Using this data, Harry Wallop, the Consumer Affairs Editor of the Telegraph, revealed that for basic rate taxpayers there are currently only three accounts paying a real rate of return, and higher rate taxpayers only have one. Something even more shocking when you consider that there are 2,203 accounts on the market.
Inflation in Europe is lower than in the UK, but even here it is starting to rise. Overall EU inflation was 2.3% in October, compared to 1.7% in January. In Portugal it has shot up from 0.1% in January to 2.3% in October. In Spain it was also 2.3% in October compared to 1.1% at the start of the year. Cyprus is closer to the UK with 3.2% inflation in October, whereas France is lower is 1.8%. Your personal rate of inflation may be higher than the average, depending on what you spend your money on each month.
In the UK, BoE deputy governor Charlie Bean admitted that the Bank has underestimated inflation since it had expected more downward pressure on prices from spare capacity. However, he said that ?it may be some while yet before normality is restored?, which seems to imply that the Bank does not see any need to raise interest rates in the near future.
Unfortunately for savers, the general expectation is that we will have to wait until final quarter of 2011 for a rate rise. If we do get one earlier, it would just be a ?token rise? of 0.25%. A Reuters poll of 67 economists in early December predicted that the first BoE rise will come next October and that the rate will then remain 0.75% until the end of 2011. A month earlier the same poll had forecast that the rate would close 2011 at 1%. Back in April it was expected to reach 2% by the end of 2011.
Some economists believe we will have to wait until 2012, while the Ernst & Young Item Club have warned that rates could remain at a historically low level for several more years. It says that although economic data has been a little stronger recently, significant downside risks remain, particularly from the Eurozone debt crisis. ?Assuming that the government tightens fiscal policy as planned, we expect the bank rate to remain at 0.5% for several years.?
Roger Bootle of Capital Economics also said that ?there is still, in my view, absolutely no reason for the MPC [BoE Monetary Policy Committee] to raise interest rates for a long time?.
On the day the UK inflation data was released (14th December), the London Stock Exchange closed at a 2.5 year high, in stark contrast to what is happening with interest rates. Many experts warned that savings accounts are a ?waste of time?, whereas they are upbeat on prospects for the stockmarket.
If you leave all your savings in the bank, you know that at the moment that your chances of earning a real return are very slim. If on the other hand you invest them with equities, although the value can fall as well as rise your capital does have the opportunity to grow and give you a return above inflation.
Equities are not the only option for those looking for an alternative to their cash savings. While you can invest in funds which provide an income through dividends, you can also invest in bond funds and real estate investment trusts, both of which also generate a natural income.
When looking to move money out of cash it is important to consider what other investment assets you currently own and what your objectives are. Speak to an experienced wealth manager like Blevins Franks for peace of mind that your portfolio is specifically designed around your risk tolerance, aims and personal circumstances. While investing money always carries some risk, so does leaving it in the bank (in terms of inflation eroding its spending power) and professional advice will give you reassurance that you are not taking on more risk than you need to.
The level and bases of, and reliefs from, taxation may change. Any statements based on taxation are based upon current taxation laws and practices which are subject to change.
By Bill Blevins, Managing Director, Blevins Franks
15th December 2010