AT ITS MEETING ENDING 3rd
August 2016, the Bank of England’s
Monetary Policy Committee (MPC)
voted for a package of measures
designed to provide additional support
to growth and to achieve a sustainable
return of inflation to the target. Most
notably, this package
comprised
a 0.25 basis
point cut in
Bank Rate to
0.25%. This is
now a record
low for UK
interest rates
and the first cut since 2009.
The Bank of England also
signalled that rates could go lower
if the economy worsens. The Bank
announced additional measures to
stimulate the UK economy, including
a £100 billion scheme to force banks
to pass on the low interest rate to
households and businesses. It will also
buy £60 billion of UK government
bonds and £10 billion of corporate
bonds.
How will the changes
affect you?
The base rate changes will have an
impact on mortgages, savings and
exchange rates. Here’s a brief synopsis
of what I feel the effects will be:
- Some mortgages will get
cheaper. Around 1.5 million homes are
on tracker mortgages, and these should
drop, though fixed rates won’t change
and with others it’s not clear-cut. - It’s more bad news for savers. Savings rates have been very
low for years and are now likely to fall
further, although if you’ve a fixed rate
account you’re protected for the time
being. - The pound has fallen further. In the
immediate wake of the announcement we saw a
further drop
in sterling –
the pound
already bought
fewer euros
and dollars
following
June’s Brexit
vote. - If you’re close to cashing in a private
pension, there may be an impact. I feel
that those planning to convert a pot
of pension cash into an annuity (an
income for life) are likely to face lower
payouts as a result of the lower interest
rate.
Will the changes improve
the UK economy?
Many financial analysts don’t believe
this recent interest rate cut will help
the economy. Savers have already
glumly accepted they are earning next
to nothing on their cash, and a quarter
of a percentage point less interest isn’t
going to persuade many to suddenly
go out and spend their savings thus
stimulating the economy.
In fact, and somewhat perversely, if
you are relying on savings interest to
cover expenditure needs, lower rates
mean you need to save more – exactly
the opposite of what the Bank of
England wants you to do!
Likewise, the cost of borrowing is
already low – marginally lower rates
aren’t going to persuade individuals and businesses to ignore
all the uncertainty
and borrow to invest.
I believe the main
message to take from
the interest rate cut
is that ultra-low rates
are here to stay for
the long term. It
now seems highly
likely that rates are
not going to rise for
at least the rest of this decade, and
possibly longer.
In reality, investors are going to
have to get used to earning very little
on their cash savings for much longer
than they ever thought. The inevitable
consequence of this is that investors in
search of a return on their capital are
being forced into riskier assets. After
all, money is very much like water – it
always flows somewhere.
It is my view that the next
destination for many people fed up
with ultra-low savings rates may have
to be to look at the possibility of a
stock market-related investment – and
in particular funds that provide an
attractive yield, although individuals’
appetite for risk must obviously be
taken into account. Sectors such as
multi-asset income and equity income
certainly spring to mind in this regard.
For instance, the gap between the yield available on an equity income fund
(generally between 3-5% per annum)
and the interest available on cash is
now larger than at any other point I can
remember.
In summary, more and more
investors and savers happy with the
additional risks of investing will have
to consider turning to dividends for
their income needs, once they have
built up a sufficient cash buffer to cover
emergencies.
However, how does this relate to the
investor in search of growth? History
has shown that the majority of long-
term stock market returns has come
from dividends. The compounding
effect of re-invested dividends is an
enormously powerful way to grow
wealth over the long term, which is why
many believe that income funds can
often make a very attractive proposition
for capital growth objectives also.
