Ultra-low interest rates: don't expect money for nothing
The current, historic low interest rate environment adds to the case for investing if you want to try to get more from your money.
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The Bank of England’s decision to keep interest rates at a historically low 0.1 per cent last month raised eyebrows from much of the market. The BoE had hinted that concerns around UK inflation might see them become the first central bank to raise rates since the pandemic began.
Since then, inflation has jumped to its highest level in almost a decade, reaching 4.2% for the year to October. This sparked firm belief among investors that the BoE will finally do the deed and raise rates when it meets this month. Although the recent impact of the Omicron Covid variant could change that.
Whatever happens, interest rates are likely to stay low. As Coutts’ Chief Investment Officer Alan Higgins explains: “Even the pressure to curtail inflation should only see rates rise by a fraction of a per cent, probably to 0.25 per cent.”
That could be seen as a compelling case for investing.
Alan says: “The days of healthy returns above inflation from sitting on cash are long gone. The ultra-low interest rate regime endorsed by central banks since the 2008 financial crash isn’t going to change any time soon.
“People need to look elsewhere – investing for example – to try to grow their money faster than inflation over the long term. None of us can expect money for nothing any more.”
It’s worth remembering that, when investing, the value of your investments can fall as well as rise, and you may not get back what you put in. You should continue to hold cash for any short-term needs.
“The ultra-low interest rate regime endorsed by central banks since the 2008 financial crash isn’t going to change any time soon.”
Alan Higgins, Chief Investment Officer, Coutts
Low rates likely to remain for some time
At Coutts we believe the factors pushing inflation up and causing central banks to revisit their growth-supporting policies – which include surging energy prices and supply chain disruption – could be temporary, and interest rates could stay low for some time.
The BoE’s caution at the start of November may have been a bit of a surprise, but it was understandable for many reasons.
For one, governor Andrew Bailey has pointed to the state of the labour market following the end of the furlough scheme as a reason for the bank’s disinclination for change.
And more generally, the UK economy has a high level of interest rate intensity – meaning even a slight rate rise can significantly change the growth outlook. And the last thing the BoE wants is to stymie the post-pandemic recovery.
The BoE basically continues to tread a fine line between raising rates to tackle rising inflation, and leaving things alone as the economic engine revs back up to speed. So keeping rates low would appear to be in their interests as they try to keep UK economic growth on track.
the economic picture
The emergency support introduced by central banks around the world when the pandemic struck is slowly being withdrawn. As well as the BoE potentially raising interest rates, at the start of November the US Federal Reserve (Fed) announced it would reduce its bond-buying programme by $15 billion a month. And America’s central bank has since indicated that it could withdraw its stimulus faster than initially planned.
But the economy currently looks like it can stand on its own two feet – although it will take time to understand the full implications of Omicron. Looking at what happened previously, the loosening of Covid restrictions prompted a spending rebound and an extreme, V-shaped economic recovery.
This was most recently shown by US retail sales, which fell by 20 per cent in 2020 then bounced back by 50 per cent this year.
That rebound is now slowing, but economic growth is still expected to revert to the norm depending on the impact of Omicron – with UK GDP on track to return to pre-Covid levels in the first quarter of 2022.
us retail sales good example of v-shaped recovery
Seasonally adjusted advance monthly sales for retail and food services. Source: US Census Bureau, December 2021
The world of investing today
So what does the investment landscape look like right now? Equities have been doing well most of the year, recovering quickly from the shock of the pandemic. The MSCI World Index returned 19.4% so far in 2021 (as at 30 November, local currency terms, income reinvested). Though markets are now adjusting to volatility from Omicron.
Bonds, conversely, weren’t really bringing home the bacon for most of the year, although their relative safety compared to riskier assets like equities did make them more popular when Omicron unsettled markets. Their lacklustre performance before then was partly because of the potential for higher inflation and interest rates, which can be challenging for bonds. US government bonds, for example, returned -1.8 per cent as at 30 November.
But bonds provide valuable diversification, and here at Coutts we believe in the benefits of a well-diversified portfolio. They offer a regular income in the shape of yield and provide a counter-weight to the equity markets where the chance of greater return comes with greater risk.
This is what we’re seeing right now – bond prices have risen (yields have dropped) because of their standing as a ‘safer’ asset during a time of renewed volatility in equity markets. Cash may well lose value to rising inflation, but diversified investments could be one way to realise returns.
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Past performance should not be taken as an indication of future performance. The value of investments, and the income you receive from them, can fall as well as rise and you may not get back what you put in.