By Nick Cairns, Partner, Blevins Franks
There was much discussion last year as to when, rather than if, the UK interest rate would rise in 2015. After six years of just 0.5 per cent, even a small increase would be welcomed by savers.
However hopes of a Bank of England (BoE) rate rise appear to have already been quashed. Many analysts now expect the first increase to come in 2016, possibly after the first quarter, with a few suggesting 2017.
Minutes of the BoE’s first Monetary Policy Committee (MPC) meeting of the year were released on January 21 and revealed that the vote to keep rates on hold had been unanimous. The two members who had been calling for a rise since August had reversed their decision. This was a significant change in the path interest rates were expected to take this year.
MPC members are concerned about low inflation after UK inflation fell to 0.5 per cent in December, its lowest rate for 14 years. Lower oil prices coupled with a supermarket price war could keep inflation below 1 per cent for some time. They believe there is a “roughly even chance” that inflation could fall into negative territory. Although the sharp drop in price pressures is expected to be temporary, a rate rise would increase the risk of low inflation becoming entrenched.
Lower oil prices could help the economy by boosting real incomes and lowering production costs, but deflation could damage the economy if it continues for a long period.
The MPC will probably only consider raising rates once all the downside risks to the medium-term inflation outlook have passed. The eurozone also continues to pose a risk. It is the UK’s biggest export market and already in deflationary territory. Quantitative easing is likely to weaken the value of the euro, which would be positive for Europe’s exporters but hurt manufacturers in the UK.
European Central Bank quantitative easing
The European Central Bank (ECB) interest rate has been held at 0.05 per cent since September 2014. Inflation was -0.2 per cent in December.
On January 22, ECB President Mario Draghi unveiled plans for a massive quantitative easing programme to boost the economy and ward off deflation.
Under quantitative easing, a central bank pumps money into the economy by buying assets, usually bonds, with money printed (or created electronically these days) for the purpose.
From March, the ECB will buy €60 billion of private and public bonds each month. This is intended to continue until September 2016, making at total of €1.1 trillion.
This move has been described in the press as the ECB’s “big bazooka”. It is hoped it will inspire confidence in the markets and prove effective in kick starting the economy, as happened with the UK and US quantitative easing programmes.
Tempted by higher rates?
With interest rates remaining low, cash deposits offering higher rates could be tempting. However, you need to consider the ‘risk free rate of return’ – the theoretical rate of return of an investment with zero risk. To measure the rate, investment managers often use the return available on government fixed interest investments maturing within three months. This is currently 0.05 per cent for the euro, 0.5 per cent for sterling and 0.25 per cent for the US dollar.
So if you see offers of risk free returns which are much higher than the international monetary bank base rate, you have to wonder how they provide such returns. We would urge caution; in our experience, if something seems too good to be true, it often turns out to be the case. Cash based deposits quoting returns in excess of the central bank rates must bear some risk, and the higher the return, the higher the risk.
As always, when considering your savings and investment options, you need to choose assets based around your personal circumstances, objectives, risk profile and time horizon. And remember, diversification helps lower risk, so make sure you have a suitable mix of assets. Seek professional advice.
