Interest rates fall below freezing
Dr Benjamin Holdsworth shows why your cash is not a sensible long-term option. So ensure your longer-term assets are sensibly invested.
Today, government bond yields and bank deposit rates sit very substantially – and uncomfortably – below where they were five and ten years ago, in negative after-inflation terms and more or less zero before inflation terms.
In March 2020, the UK Government issued its first negative-yielding gilt, borrowing £3.8bn at -0.003% for a three-year maturity. The negative yield means investors who hold the debt to maturity will get back less than they paid.
On a retail basis, falling yields are evidenced in the NS&I products on offer from the UK Government. The days of index-linked certificates at inflation as measured by Retail Price Index + 1% seem like nirvana.
The recent slashing of rates across the board on NS&I products leaves savers struggling to cover the erosion of their cash by inflation.
Negative interest rates
The Bank of England – alongside other central banks – has hinted that negative interest rates remain in its arsenal of tools to help the economy. Denmark has already seen home loan offers at a negative interest rate, meaning that mortgage borrowers pay back less than they borrow!
One can perhaps see why the ‘Old Lady of Threadneedle Street’ – the nickname for the Bank of England since a cartoon published in 1797 – sees this as a useful stimulant in helping firms and consumers to have the confidence to borrow.
However, if commercial banks are charged for placing deposits with the Bank of England, then, in all likelihood, they will pass these costs onto retail depositors.
In effect, negative interest rates represent a transfer from savers to borrowers. There would also appear to be limitations to negative rates, as banks and individuals might well decide to hold bank notes instead at no cost if negative interest rates persist.
A possible solution
One possible solution is to run a system of dual interest rates.
Specifically, this could be targeted at one rate for bank lending – for example, 1% – and one for bank deposits, such as +0. 5%.
Various terms and conditions could be applied, such as directing the type of lending the banks could do with this facility.
It has even been suggested that this could be used to drive a new ‘green deal’ where money would be available to companies focused on sustainability.
Borrowers’ net income would rise, as would the benefits of greater economic stimulus through lending to companies to invest in projects. At the very least, this is an interesting concept.
The one thing that is certain is that it will be extremely hard to preserve the purchasing power of cash in the coming months and possibly years.
Having enough cash to meet emergency liquidity needs is important, but make sure that any longer longer-term assets are sensibly invested.
Dr Benjamin Holdsworth (right) is director of Cavendish Medical, specialist financial planners helping consultants in private practice and the NHS
The content of this article is for information only and must not be considered as financial advice. Cavendish Medical always recommends that you seek independent financial advice before making any financial decisions.
Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor. The value of investments and the income from them can fluctuate and investors may get back less than the amount invested.