David Battersby examines the Bank of England’s decision to cut interest rates to support business and maintain confidence.
The Bank of England has announced its first movement in interest rates since March 2009. A cut from 0.5% to 0.25%. The reason: potential volatility following the British vote to leave the E.U., as their forecasts suggest a slowing down in the UK economy, as the governor Mark Carney has committed himself to do whatever it takes to support business and maintain confidence.
Whilst the rate cut itself is largely symbolic given the prolonged low interest rate environment, it came with a package of measures including further quantitative easing through the creation of £60 billion to buy back UK government bonds and £10 billion for corporate bonds.
In addition, they announced the creation of a £100bn Term Funding Scheme designed to offset the impact of cutting interest rates on bank profits, meaning that there was “no excuse” for banks not to pass on the lower rates to borrowers.
At the same time, Mark Carney, in line with his policy of forward guidance said interest rates could be cut to 0.1%. This has sparked discussion on the potential for negative interest rates, already prevalent in Sweden and Japan. In fact, if you take the Retail Price Inflation of 1.6% into account, the UK already offered a negative real rate of return of 1.1%, and this has now widened to 1.35%.
For savers, this is bad news as not only is their money earning practically nothing, it is now worth less the longer they leave it in the bank.
The options therefore (which is what the Bank of England wants to encourage) are to spend it or invest it. This has boosted the flow of funds into the stock market where returns are historically greater, but not without risk.
A consequent hunt for yield has meant that income portfolios have outperformed growth portfolios, a phenomenon that will likely persist whilst returns on deposit remain so low but the situation will not last forever. At the start of the year, rates were forecast to rise in December, but following Brexit, all bets are off with analysts now looking beyond 2020.
Those concerned that quantitative easing will create too much inflation have sought out gold to hedge against this risk. However, the stimulus has not thus far resulted in inflation as there has not been a corresponding increase in discretionary spending. As gold provides no income, there is a cost for its storage. Priced in dollars and with US Federal officials signalling potential interest rate increases this year, analysts are cautious on the outlook for this rare mineral.
Whilst the general consensus is that we have not seen the end of monetary easing in the U.K., there is a risk that markets become reliant on this as evidenced by rising equity markets making it difficult for rates to normalise without creating a loss of investor confidence. A concern has risen as this is the lowest interest rates have ever been in the Bank of England’s 322 year history.
