When the Bank of England cut base rate to 0.5% in March 2009, nobody was expecting that nearly seven and a half years later the Bank’s next move would be a further cut to 0.25%, but that is what happened in early August. At the same time the Old Lady announced several other monetary measures designed to keep down interest rates and encourage borrowing.
The aim of the Bank’s actions was to stimulate borrowing and help UK plc survive the downturn, widely predicted as a consequence of the Brexit vote.
Whether a 0.25% reduction in interest makes that much difference to business investment decisions is a moot point. There was an element of being seen to do something as the government had made clear it would not act before the Autumn Statement on 23rd November.
The interaction by the Bank of England had a number of effects. Predictably, the main banks and building societies began announcing cuts or reviews of their interest rates for both depositors and borrowers. This is becoming ever trickier, as base rate nears zero.
One bank went as far as to tell some of its larger business customers that they would be charged for making deposits. At present this negative interest rate treatment is unlikely to hit personal savers, although once inflation is taken into account (the September RPI was 2%), in real terms if you leave money on deposit you are already seeing the value of your capital fall.
The Bank’s pledge to buy £60bn of government bonds over a period of six months (and £10bn of investment grade corporate bonds) drove down yields on fixed interest securities to record lows.
As of late August, the prospective annual return on a ten-year government bond had fallen to just over 0.6%. This has prompted suggestions that far from offering risk-free returns, government bonds and bank deposit accounts are now offering return-free risks. With yields so low, a small drop in the 10 year bond price can wipe out several years’ income at a stroke. And for bank deposit accounts, the real return on capital has been negative for months. Now that the rate of inflation is picking up, deposit capital is losing buying power at a rate of knots.
One corollary to falling long-term rates is still lower annuity rates. The best age 65 fixed annuity rate is currently about 4.6%, making last year’s very low rates look (with hindsight) a steal. That is a reminder of the danger in waiting for things to improve – they may get worse.
What can you do?
There are no simple answers, as what you do will depend upon your personal circumstances. If you are a mortgage borrower you may see no difference as over half of all mortgages are now fixed rate and so immune from base rate changes until the end of the fix period.
If you have money on deposit then, even with the benefit of the personal savings allowance introduced in April, inflation is beating your return. Once you have set aside enough cash to provide a rainy day reserve, you need to have a good reason to hold any more on deposit.
If your requirement is income, then deposit-based investments are unattractive unless you require total security of capital (subject to the usual deposit protection scheme limits). The average yield on shares in the UK stock market is now around 3.5%, which puts even five year fixed rate deposits into the shade.
In terms of annuities, the starting point is to review whether annuity purchase is appropriate, given that the guaranteed income on offer now has a very high price tag. If you decide it is then make sure you get expert advice on the choice of annuity for your circumstances. There are many factors that determine annuity rates these days and they cannot be captured in brief weekend press league tables.
Interest rates look set to stay even lower for even longer, despite inflation being likely to rise due to the weak pound.
Whether you are looking for income from your capital or your pension plan, it is more important than ever to obtain advice on all your options. “Just leave the money on deposit for now” is unlikely to make financial sense.
Stephen Watson is Managing Director of Watson French Ltd & My Auto Enrolment Ltd. Passionately independent, Stephen has been advising clients on financial matters since 1978 and has extensive experience in financial planning.
Tel 01872 225885