Interest rates remain low for now

Unsurprisingly, both the Bank of England (BoE) and European Central Bank (ECB) kept interest rates on hold at their June monetary policy meetings.

In the UK, the base rate has been 0.5% for over six years. Minutes of the bank’s Monetary Policy Committee (MPC) May meeting revealed that although the bank expects rates to rise, this will not happen for some time.

The committee members have been unanimous this year in their decision not to raise interest rates. The two members who were voting for a rise over the second half of last year reversed that decision in January.

One key issue is inflation. The BoE has a target of 2% for the Consumer Price Index, but it has been falling as a result of lower oil prices and ongoing supermarket wars. It fell into the negative territory of -0.1% in April, the first time since records began.

Back in March, concerns over low inflation prompted MPC member Andrew Haldane to suggest that a rate cut was as likely as a rate rise. However, BoE Governor Mark Carney soon stated that low inflation was unlikely to make the bank cut its base rate below 0.5% and that the next move would be up.

Besides the inflation issue, growth was also sluggish at the start of this year, at 0.3% for the first quarter. This was largely a result of a disappointing trade performance, with UK exporters hit by the weaker Euro, which makes their goods less competitive in the Eurozone, their biggest market. The BoE is reluctant to increase rates too soon and risk stalling the recovery.

Economists now forecast that the first rate rise will come in 2016.

Samuel Tombs, senior UK economist at Capital Economics, said he does not expect an increase until the second quarter of 2016. It would then move to 1% by the end of that year, reaching 1.5% by the end of 2017.

If the BoE’s base rate does reach 1.5% by the end of 2017, this would still be a long way off from the 5% we had before the banking crisis hit in 2008. We are in a different economic environment and could see many more years of low interest rates.

Various factors will come into play though. Besides inflation, the BoE will be looking at how economic growth, earnings and productivity develop over the coming months, as well as external factors such as fears of Greece leaving the eurozone.

In the eurozone, the ECB’s governing council also kept interest rates unchanged at its June meeting. Its benchmark main financing rate is 0.05%, and it continues to charge deposits parked by eurozone banks at the ECB at a rate of 0.2% (effectively a negative interest rate).

There are signs that the economy is slowly starting to recover, with consumer prices moving higher.

Whereas the bank had previously forecast a 0% inflation rate for 2015, it has now revised this up to 0.3%. It expects low oil prices to keep inflation low for the next few months, but it should then rise by the end of the year. It forecasts 1.5% next year and 1.8% in 2017, almost reaching its target of 2%.

Eurozone growth is expected to reach 1.5% this year, 1.9% in 2016 and 2% in 2017.

The eurozone has been suffering from deflation, with the official inflation rate falling to -0.6% in January. It remained negative for February and March, rising to 0% in April and 0.3% in May. The improvement is attributed to the bank’s quantitative easing programme and eased concerns that Europe could suffer a prolonged period of deflation.

The bank will continue with quantitative easing as planned, where it expects to buy €1.1 trillion of sovereign bonds and private sector debt by September 2016, in an attempt to stimulate the economy and ward off deflation.

ECB President Mario Draghi said the programme was going well and reiterated that it was intended to run to September 2016. He stated: “Our monetary policy measures have contributed to a broad-based easing in financial conditions, a recovery in inflation expectations and more favourable borrowing conditions for firms and households.” However, he acknowledged that there has been some loss of momentum in the economic recovery, mainly due to the weakening of external economies like emerging markets, and that the ECB had expected stronger figures.

How much of the investible capital you hold in cash should depend on your personal circumstances, aims and risk tolerance – and not on speculation of what interest rates may or may not do. Remember that keeping too much in cash carries the risk of losing spending power over time. You need a clear and objective assessment of your attitude to risk to establish the savings and investment strategy that suits you best, and should take professional guidance on this.

By Gavin Scott
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Gavin Scott, Senior Partner of Blevins Franks, has been advising expatriates on all aspects of their financial planning for more than 20 years. He has represented Blevins Franks in the Algarve since 2000. Gavin holds the Diploma for Financial Advisers. |

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