Interest rates kept on hold

In an unsurprising move the Bank of England has left interest rates on hold at 0.5% for a 12th consecutive month.

The Bank also announced no change to the policy of leaving Quantative Easing (QE) on hold for the time being.

These decisions reflect the delicate balancing act that the Bank needs to perform in its quest to help the fragile economic recovery with economists believing that any rise in the cost of borrowing would have a harmful effect on the recovery.

The indications are that interest rates will remain low for most, if not all, of 2010. However, if inflationary pressures in the economy continue, created by the policy of QE, this could lead to a rise in interest rates sooner than expected. The latest inflation figures, released last month, showed the annual inflation rate rising by 3.5% in January, the fastest annual pace for 14 months. This compares with 2.9% the previous month.

The Bank believes that the inflationary spike is temporary, and is mainly due to the increase in VAT at the start of the year.

The news that base rate is to stay unchanged will be welcomed by homeowners who have a Tracker mortgage linked to Bank Base rate, however for savers it is far from a rosy picture. They are being hit from two sides with inflation rising and low interest rates on their savings, meaning that it is hard for them to get a real return above inflation.

Over the next few days we will be highlighting the best buy savings accounts that provide a real return above inflation.

Inflation rises to 3.5%, savers hit

The Bank of England have announced that that UK Consumer Price Index (CPI), which does not include housing costs, rose to 3.5% in January from 2.9% in the month before. The Retail Price Index (RPI), which does include housing costs, rose from 2.4% to 3.7%. Whilst this is in line with expectations it still represents the fastest annual rise for the past 14 months and it means that the Governor of the Bank of England, Mervyn King has had to write to the Chancellor explaining why inflation had risen above the agreed target of 2%.

In his letter the Governor explains the reasons for the rise:
“First, the restoration of the standard rate of VAT to 17.5% is raising prices relative to a year ago. Second, over the past year, oil prices have risen by around 70%. That is pushing up petrol-price inflation significantly, which, in turn, is raising overall CPI inflation. Third, although the exchange rate has been broadly stable over the past year, the effects of the sharp depreciation of sterling in 2007 and 2008 are continuing to feed through to consumer prices.”

The letter went on to say that the rise in inflation is expected to be temporary and it should return to below the 2% target in the second half of this year even with historically low interest rates.

The news of higher inflation in the short term is not good for savers who are now being attacked from two sides, not only do they have to accept lower interest rates but inflation is now significantly eroding the return that they are actually getting. For example the most competitive instant access Cash ISA currently pays 2.75% (Source Investment Sense Best Buy Savings Accounts) with both the CPI and RPI above this level the real value of money is starting to be eroded.

Although the reasons for the inflationary spike are to be expected and somewhat historical, pointing to the fall later in the year predicted by Mervyn King, this will be of little comfort to savers in the short term who face a struggle to find interest rates that will preserve the real buying power of their money.

Repossessions at a 14 year high

Despite schemes introduced to help people who are faced with eviction there were a total of 46,000 repossessions last year, a 14 year high and 15% up on 2008.

However, the help that is offered by government, low interest rates and lenders being urged to be more sympathetic may go some way to explain that repossessions in the fourth quarter of 2009 were 13% lower than in the third quarter.  Although it would appear that only 92 people have actually benefited from the Mortgage Rescue Scheme, which may indicate the environment of lower interest rates is actually providing more practical assistance.

In addition to the repossessions figures it was reported that 188,300 mortgages were in arrears in 2009

Both the arrears and repossession figures are below initial estimates made by the influential Council of Mortgage Lenders (CML) who predicted repossessions would be 75,000 in 2008 and those in arrears 195,000.
The picture for 2010 in uncertain with the economic recovery still fragile, inflation rising in the short term and the number of unemployed still relatively high.

The news was given an unexpected twist by James Healy, the government’s Housing Minister who said, speaking on BBC’s Radio 5 Live, “In some cases there is no way round that and in some cases it is the best thing for the people who are struggling with these mortgages.”

Given the opportunity to clarify, he repeated: “Sometimes it is impossible for people to maintain the mortgage commitments they’ve got … it may be the best thing in those circumstances.”

Mr Healy’s comments, whether right or wrong, have caused a certain degree of controversy with many accusing him of being out of touch, one thing is for sure, his comments will be of little comfort to those people who have lost their homes.

The benefit of hindsight

What is the most useful tool a successful investor could have? Strong research? Access to company management? A prodigious memory? These are all useful – perhaps even vital – attributes. However, the most useful tool is the one thing nobody can have: the benefit of hindsight.

As long experience shows us, different asset classes and industry sectors will provide strong or weak performance at different times. For example, equities are widely acknowledged to have provided the best long-term performance of the four main asset classes - but most investors who lived through the meltdown of the "dot-com" sector know only too well that, in the short term, things can be quite different. Bonds on the other hand, are viewed as medium to lower-risk investments, particularly when economic growth is on the wane - but the recent credit crunch left many with burnt fingers. Meanwhile, in times of uncertainty, investors make tracks for the safe haven of cash – but leave your money there too long and the value can fall prey to the corrosive effects of inflation.

The theory runs like this: during periods of strong economic growth, equities are likely to perform well, whereas when economic growth is in decline, bonds and cash should prove more beneficial. "Specialist" asset classes – such as commodities and property – are also available and can perform differently from all of the above. However, do note - these need expert advice and should be approached with a degree of caution.

What can be tempting for investors is to chase the best returns by jumping from one asset class to the next when the returns look promising. However, in reality this rarely works. If judging the right time to switch and where to switch to were easy, we would all be rich. Even some of the full-time, so-called professionals consistently get these decisions wrong. Therefore, instead of trying to choose which asset class to be in and when, perhaps it would be better to have a bit in all the asset classes, all of the time.

This is called diversification – the act of spreading your investment across more than one asset class. In doing so, you not only make sure you are invested in the asset class that is performing best, you also ensure you are not 100% invested in the asset class that is doing worst. Instead you get a bit of everything – and as a result, your investment returns should be smoothed out as performance rotates through the asset classes and each compensates for another as time goes by.

Interest Rate Cut - 9th October 2008

The Bank of England’s Monetary Policy Committee (MPC) voted to keep rates on hold at 5% for the fifth month running at its September meeting. The decision was widely expected as, despite ongoing pressures in the housing and financial sectors, inflation had become a serious issue. Interest rates had been held because inflation was ahead of target. Now, inflation has hit 4.7% and previous MPC minutes indicated they had switched emphasis from supporting economic growth to damping down these inflationary effects. In the last month, however, things have changed considerably. The housing market was already faltering, and the credit markets remain tight. UK Government measures to help had generally been met with apathy. UK GDP has now officially hit zero and some fear we are already into a recession. The final straw, however, was the financial sector. Lehman Brothers sought bankruptcy protection and AIG was bailed out by the US Federal Reserve. In the UK Lloyds TSB has agreed a rescue takeover of HBOS and the oil price has fallen back. Now, Bradford & Bingley has been nationalised as confidence in its future crashed. All in all, the outlook for the economy was looking bleak. The Bank of England, in common with the US and European central banks, decided to move. Their unexpected 0.5% cut brings rates down to 4.5%.

Future of Interest Rates

Interest rates have now been on hold for five months and many feared the next move would be upwards. However, that was before the events of this week changed the complexion somewhat.
The Consumer Price Index is now 4.7% - more than double the Bank of England’s 2% target. UK GDP is zero (and may now, in reality, be negative), the oil price has fallen back and the housing market has completely stalled. Couple this with investment bank failures, the nationalisation of a US insurance company and now the merger between HBOS and Lloyds and the outlook is looking bleak.
A interest rate cut is perhaps back on the agenda; such a cut would be welcomed by both consumers and business and if it materialises would hopefully give a little relief from the current economic woes being experienced by all.

Bank holds interest rates at 5%

The Bank of England's monetary policy committee (MPC) has voted to maintain interest rates at 5% for the fifth consecutive month as it attempted to steer a course between the twin dangers of soaring inflation and faltering economic growth.
With the UK's economic output grinding to a halt in the second quarter of the year and house prices continuing to fall, Mervyn King's nine strong committee would have been under severe pressure to deliver the right decision.
CPI inflation hit 4.4% in the year to July, and King warned it could breach the 5% level by the end of the year, well above the 2% target set by the Treasury.
Charles Stanley chief economist Edward Menashy commented: 'The no change decision was made despite the latest OECD forecast that indicated that UK GDP growth would be 1.2% lower than the 1.8% growth estimate that the organisation had made three months ago.'
Newton's global strategist Peter Hensman said the rate hold was no surprise, but noted that interest rate rises had led one member of the MPC to vote for a rate hike last time round.
He said: 'One [MPC] member, Professor Tim Besley, specifically voted for a rate increase to reduce the threat that inflation expectations drift higher, a fear that has increased with the recent sell-off in sterling.
However, the evidence of a weakening growth environment is sufficient in the near-term to keep policy unchanged.'