24 May 2017

5th June 2017 is a notable anniversary for the Bank of England and British savers – it marks 100 months since the Sterling interest rate was cut to the historic low of 0.5%.

It has also been 10 years now since we saw a UK interest rate hike. The last time the Bank’s Monetary Policy Committee raised its rate was in May 2007, up from 5.25% to 5.5%.

Then the financial crisis hit and rates kept falling until they reached 0.5% in March 2009. They remained frozen for years until we finally saw a move last summer – downwards. The rate was cut from 0.5% to 0.25% in the wake of the Brexit referendum, with no change since.

LONGEST LOW SINCE SECOND WORLD WAR!

The last time rates were kept low for so long was around the Second World War. Then the rate was held at 2% (which actually sounds good today!) from 1939 to 1951.

With Brexit around the corner, and the negotiations likely to be challenging for the UK economy, few would be surprised if we hit another anniversary, this time 10 years of 0.5% or lower rates. Financial markets and many commentators are not expecting the Bank of England to increase rates until 2019.

SAVERS LOSE OUT ON BILLIONS

While businesses and borrowers have benefited from low rates, it has been detrimental for savers. In March 2016, Hargreaves Lansdown calculated that seven years of record low rates and quantitative easing resulted in savers losing out on £160 billion – an average of £6,000 for every household.

The firm observed that while the monetary policy had supported strong increases in share, bond and property prices, it had “annihilated” returns on cash.

In contrast, the FTSE 100 index has increased 109% over the eight years since interest rates were cut to 0.5%, rising from 3530 on 5th March 2009 to 7374 on 5th March 2017.

SITUATION  GETTING WORSE

The situation is actually getting worse for savers as inflation is rising.

Data released on 16th May showed that UK inflation, as measured by the Consumer Price Index, hit 2.7% in April – the highest level since September 2013.

Read our article “Wealth creation and management – Five key elements for success”

At the time The Telegraph reported that there were no savings accounts paying higher interest rates than inflation. According to Moneyfacts, none of the 753 savings accounts were offering a rate higher than 2.7%, even for five-year bonds. While there are a few current accounts and monthly savers that do beat inflation, they all have restrictions. This means savers are earning a negative rate of return.

Inflation across the EU as a whole was 2% in April, or 1.9% in the Euro area. In Spain it was 2.6%, in Portugal 2.4%, in Cyprus 2.1%, in France 1.4% and Malta 1.1%.

HOUSEHOLDS FEEL THE PINCH

In the UK, the National Institute of Economic and Social Research (NIESR) warned that inflation will hit 3.5% by the end of the year, before falling back, while ultra-low interest rates will remain in place for another two years. Households will feel the pinch of rising prices, and with wages also not keeping pace with inflation, consumer spending growth will stall by 2018.

Speaking to reporters on 9th May, NIESR’s head of macroeconomic modelling and forecasting said: “We assume that interest rates remain unchanged until we exit the European Union. If the chance of a transitional deal does begin to materialize, it might well be that the Bank of England brings forward the point at which it raises interest rates, but at the moment, that doesn’t appear to be on the cards.”

TWO YEARS FOR NEW TRADE DEAL

The UK government has two years to negotiate a new trade deal with the EU, and there are many other issues that need to be resolved, possibly before the trade deal can be finalised. Britain’s economy has so far fared better than many had expected since the June 2016 referendum, but reduced trade with the bloc may have implications in future.

Brexit is starting to have a dampening effect on economic growth. Besides inflation (caused in part by the weak pound) reducing consumer spending power, businesses are more cautious about investment spending as they do not know how the UK’s trading relationship with the EU will evolve.

After its monetary policy meeting on 11th May, BoE governor Mark Carney commented that “this is going to be a more challenging time for British households”. Real income growth will be negative and wages will not keep up with prices.

THERE’S GOOD NEWS TOO

It is not all bad news. The world economy is performing well and the European economy recovering nicely, which all helps the UK economy. The Bank expects the slowdown in economic growth and rise in inflation to be temporary, and that the next three years will see wages recover significantly and a slow but steady economic growth.

Encouragingly, the central bank indicated that, if the economy lives up to the forecasts and Brexit talks go well, it would be in a position to raise interest rates from 0.25%.

However it was clear that its positive forecasts were based on the assumption that “the adjustment to the UK’s new relationship with the EU is smooth”.

This is a good time to review how you structure your finances and consider alternative options for investing. How much of your capital you hold in cash should depend on your circumstances, aims, risk tolerance and time horizon – and not on speculation of what interest rates may or may not do. However, with no compelling signs of a rise in interest rates any time soon, this is a good time to reconsider your options.

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 well-diversified portfolio to suit your personal circumstances, aims, time horizon and risk profile.