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Investment market review, August 2016

Ultra-low interest rates are here to stay but how will this trend impact investors?

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Topic: Investing

Negative Interest Rates

With the Bank of England cutting interest rates earlier this month from 0.5% to 0.25%, are we edging ever closer to a world of negative interest rates? Could we really find ourselves in a position where savers have to pay to leave their money in a bank and borrowers get paid to borrow?

It sounds unthinkable but it’s already happening in other parts of the world. Back in 2014 the European Central Bank cut interest rates to a low of 0.15% and imposed negative interest rates of -0.1% on Eurozone banks. Central banks in Switzerland, Sweden and Denmark have also moved interest rates below zero. Japan, a leader in monetary experimentation, followed in early 2016 and whilst Mark Carney, Governor of the Bank of England, has mentioned he’s “not a fan” of negative interest rates, Janet Yellen, the Chair of U.S. Federal Reserve, recently said that a change in circumstances could also “put negative rates on the table”.

The thinking behind this approach is that if commercial banks are charged by the central bank to hold their money, then these same banks will decide instead to lend more money to consumers, businesses and other banks. This will hopefully lead to more business development, more hiring of staff, more demand for credit and ultimately more active economic growth.

However, such lowering of interest rates into negative territory has never been tried on this scale before and European investors are struggling with the uncertainties. Combine this with the legacy of the financial crisis in the form of bad loans and political uncertainty off the back of Brexit and it’s fair to say Europe has had a difficult year; consequently European equities are currently offering reasonable value.

In Japan it’s probably too early to get a true picture of how negative interest rates are impacting the economy but we may already be seeing some unexpected results. Instead of falling, the yen has risen very strongly as investors view the currency as being relatively low risk amid uncertain global markets, choking off any export-led recovery and hopes for higher inflation.

Government Bonds

As central banks are often the benchmark for all borrowing costs, it’s perhaps not surprising to see negative rates across a range of fixed income securities.

This means that anyone holding a government bond with a negative yield will not get all of their money back at maturity and, at the moment, more then $12 trillion of global government bonds now promise a negative nominal yield to maturity.

This is testament to various factors including lingering fears of deflation, sluggish global growth and now political uncertainty, but overriding everything has been the aggressively loose monetary policies of the European Central Bank and the Bank of Japan.

Here in the UK, nominal returns remain in positive territory but 10 year government bond yields are still at an all-time low of just 0.55%, suggesting a rocky road ahead. The Bank of England has also recently offered to buy government bonds, as part of a programme of Quantitative Easing, effectively driving up prices and lowering the yield for investors.

So what does this all mean for you?

It’s clear that ultra-low interest rates are here to stay but at this stage it’s very difficult to predict how this trend will impact markets in the long-term. We have already seen some banks move to pass interest rate cuts on to customers, dropping rates for savings accounts after Mark Carney made his announcement, but it’s probably too soon to start clearing a space under the mattress.

There are also continued benefits that can’t be ignored. Low interest rates mean savers see low returns on their savings but borrowers will pay less on their loans or mortgages. Anyone on a tracker mortgage, for example, won’t be complaining.

However when it comes to government bonds, it’s not only investors that will be impacted: anyone about to take out a pension annuity will also feel the burn, as annuity rates are often linked directly to the current rates of gilts.

It’s no secret that we are in uncertain times but our Research Team at Click & Invest are keeping a close eye on how increasingly low interest rates are impacting the market. Click here to subscribe to our newsletter and get monthly updates.

The information in this article is for private circulation and is believed to be correct but cannot be guaranteed. Opinions, interpretations and conclusions represent our judgement as of this date and are subject to change. The information contained in this article does not constitute a personal recommendation and the investment or investment services referred to may not be suitable for all investors; therefore we strongly recommend you consult your Professional Adviser before taking any action. Copyright: Investec Click & Invest Limited. Reproduction prohibited without permission.

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