Since the global economic crisis of 2008 the Bank of England has responded by keeping interest rates at a historical low. While rates haven’t risen above 0.5% since 2009, increasing chatter has revolved around when an interest rate increase can be expected in the UK. This has only intensified since the US Federal Bank opted to increase interest rates recently, with a number of gradual increases indicated over the forthcoming year.
As it turns out the Bank of England’s Governor Mark Carney has recently gone on record to say that no interest rate increase is imminent. Indeed, while George Osborne has been vocal about warning consumers to be prepared when the rate does increase, many experts expect no change to the current interest rates until the second half of 2016, or perhaps even as late as 2017.
The question is really what this maintenance of historically-low interest rates really means for savers, investors and the general public. In short, what real-world impacts will this continued period of low interest likely have on our everyday lives.
High Levels of Borrowing
The first and most obvious effect of low interest rates is that borrowing money is cheaper than ever before. Businesses and consumers alike pay minimal interest on their outstanding debts, meaning that ever more of us are willing to take out loans, spend on our credit cards or to consider taking on a new mortgage.
In addition to this increased confidence in borrowing rates, the low repayments mean that many businesses and consumers actually have more disposable income than they might expect if interest rates begin to climb.
Economic Effects
This higher level of disposable income can have significant knock-on effects for the economy. Consumers are more likely to enjoy some retail therapy, while businesses are better-placed to make major investments in new equipment and infrastructure. Both of these elements can help to stimulate and grow the British economy.
Improved Employment Rates
With more cash-to-burn thanks to low borrowing rates and potentially increased revenues, businesses are more likely to hire additional staff. This can lead to a fall in unemployment. Furthermore, an increasing proportion of the population benefitting from gainful employment can further boost spending – and so the economy as a whole.
Inflation
So far, low interest rates seem to be nothing but good news. Who could sniff at more affordable mortgages, higher employment rates and more disposable income?
However, as with every economic transaction, there will always be a flip-side. While borrowing and spending may increase, this increasing demand can have rather less pleasant effects. One such example is that thanks to the rules of supply-and-demand the cost of importing and manufacturing products can begin to rise. As a result, the costs of living can begin to climb in real terms, actually making our disposable income less beneficial than one might first imagine.
Impacts on Import/Export Costs
With the static rate of Sterling facing up against increasing interest rates in the US, it is little wonder that the value of Sterling has fallen recently against both the US Dollar and the Euro. In essence, many currency traders are pulling funds from Sterling and instead investing in currencies which offer them healthier returns.
The falling value of the Pound can have a significant impact on international trade, essentially by making our exports more competitively priced, but having the reverse effect on imported goods.
Less-Attractive Savings Rates
One of the most insidious aspects of low interest rates is how savers can be penalized. As anyone with a savings account will be aware, the rates being offered by banks and major funds are less than exciting at present. Furthermore, it seems unlikely these will be improving anytime soon.
As an example NS&I have recently slashed their 65+ Growth Bond rates from 2.8% to 1.45%. Worse, this is still considered quite a healthy return when compared to current market averages.
With interest rates below 1% on some investments, it’s easy to see why many investors are pulling funds out of typical investment vehicles in frustration and instead looking for opportunities with healthier returns elsewhere.
This is in contrast to vehicles such as the Wellesley Mini-Bond which at the time of writing offers an interest rate of up to 8% depending on investment length, but does provide a slightly higher risk and isn’t protected by the FSCS.
Increased Value of Property
Many of these factors can combine to result in ever-rising property prices. Affordable mortgages, greater employment, higher levels of disposable income and rising asset values mean that property prices typically grow during periods of low interest rates.
This can make short-term property investments an attractive alternative to otherwise stagnant savings accounts and low-interest bonds.
Conclusion: The Impacts of Continuing Low Interest Rates
For investors, the expected continuation of low interest rates in the UK is likely to continue to make earnings less than exciting. Many of these investors are likely to move into alternative investment vehicles which offer stronger returns. While classic ISAs and savings accounts may offer reasonable, predictable returns with minimal risk, casting your investment net wider may result in higher potential gains (but also, potentially, higher risk).
For businesses, growth can continue with increased investment.
Lastly, for the average UK citizen the economic indicators suggest that we can expect property prices to keep rising for the foreseeable future while borrowing remains cheap.
Note, however, that these rates are unlikely to remain static for ever more. Osborne has stated that increasing interest rates “will be a sign of a stronger economy that is normalising after the extraordinary crisis of seven or eight years ago”.
Irrespective of which category you may fall into it is worth appreciating that interest rates are almost certain to rise in the next twelve to eighteen months. At this point, both the cost of debt and investment returns will both increase.
The intelligent investor will therefore, seek opportunities for growth in the current market conditions, but with an eye to avoid overly-leveraged positions which could result in discomfort as and when interest rates begin to rise.