The decision on whether to cut interest rates will be announced this Thursday 14 July at 12pm. Many economists believe the Monetary Policy Committee (MPC) will cut their base rate to a new low of just 0.25%. However, expectation for a 0.25% cut is pretty well priced in by markets.
Why is this being considered?
The Leave vote in the European Union Referendum was a shock for the markets. Although the FTSE 100 index has regained all its lost ground and more, the FTSE 250, which is seen by many as a better barometer of the UK economy due to its more domestic exposure, is down 3.6 % since 23 June. With consumer confidence dented and businesses holding off on spending and hiring, there is a view that either the Bank of England (BoE) or the Government needs to stimulate the economy.
BoE Governor Mark Carney has already dropped a number of hints, stating “Some monetary easing will likely be required over the summer”. However, he warned of the potential consequences of ultra-low rates. “If interest rates are too low – or negative – the hit to bank profitability could perversely reduce credit availability or even increase its overall price.”
Five ripple effects of an interest rate cut
Banking
Whilst banking stocks may see a negative impact on their performance (and therefore market valuations) with any decision to lower interest rates, a cut is more typically associated with stimulating consumer spending and housing market transactions. As Carney cautioned, though, the current economic challenges in a post-Brexit UK plc may cause the conventional stock valuation principles to prove misplaced over the coming weeks.
Carney has been very clear in stating this is not 2008. Banks are better positioned and have been through rigorous stress testing scenarios. Savers will get hit, but probably not too much given existing low rates.
Sterling & exports
The impact of a rate cut could also be felt in the currency markets, where Sterling is vulnerable and has already fallen vs the US Dollar. Market Sentiment could take it in either direction. However at current levels lower interest rates can potentially serve as a positive factor for exporters and those with significant overseas earnings such as the oil and mining sectors and luxury goods manufacturers, giving traders and investors additional opportunities to consider. Around 70% of FTSE 100 revenues are derived from abroad.
Savers
With interest rates already at record lows, savers have been getting very little return from holding cash. A further rate cut would reduce their spending power yet further, and encourage anyone still holding cash to look at more risk assets such as equities or further afield to corporate and high yield bonds, infrastructure and emerging market bonds. Take a look at our articles on alternative sources of income:
Alternate sources of income: Infrastructure
Alternate sources of income: High Yield
Pensions
Anyone looking to secure an income for retirement will already be impacted by lowering annuity rates as a result of gilt yields plummeting following the Brexit vote. Already annuity rates have fallen in the region of 3 to 3.5%. Lower interest rates are likely to drive yields lower still. If you don’t need to take your pension then it’s probably best to sit tight but if you do it’s important to understand that the rates you get now are locked in for retirement, so it’s important to shop around for the best rate available. Another option would perhaps be to consider a mix of Income Drawdown (taking funds directly from your pension pot) and an annuity to give you a blend of security and income flexibility. Read more about what Brexit could mean for your pension.
Consumers
A closely watched consumer confidence survey by market researchers GfK last week recorded the biggest drop in sentiment in 21 years, and the BoE is keen to address this.
It has already taken steps to release up to £150 billion worth of lending to households and businesses by relaxing regulatory requirements on the banking sector. Any cut in interest rates could also be good for mortgage borrowers, although the lower rate would not necessarily be reflected in variable mortgage rates.
What next?
People have been talking about “lower for longer” for interest rates for some time. Now it looks like they will be even lower for even longer, with few predicting any rise before 2020. But anything can happen with the unprecedented political upheaval that we are seeing and with Theresa May at the helm, we expect that there could be more leftfield change. Great news though that the Government has taken swift action to steady the ship and provide a little confidence for investors. Remember, we’re always here to do the same!
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