The Bank of England decided to keep the pressure on savers this week, voting 7 to 1 for keeping interest rates at an all-time low of 0.25%.
Rates have been low since the financial crisis, so this pressure is nothing new. What’s interesting is that inflation is currently ahead of the Bank of England’s 2% target, and it’s unlikely to stop there. The Monetary Policy Committee (MPC) reckons it could surge to around 3% by the end of the year.
The Bank of England would typically increase interest rates with inflation running above their target. So, why did the MPC members vote 7 to 1 in favour of keeping the bank rate at an all-time low of 0.25%?
Inflation’s enthusiastic streak has been pinned on the devaluation of sterling following last summer’s Brexit referendum, which is now feeding into the price of consumer goods. As around a third of the stuff we buy in the shops have been imported, a weaker pound makes them more expensive – I’ve certainly noticed it.
Sterling may be up 2.3% since Prime Minister Theresa May called a snap election last month, but it’s still around 16% below its November 2015 peak.
Attempting to unwind sterling’s impact on inflation right now could increase unemployment and squeeze income growth, instead. The bank seems happy with the notion that if sterling remains stable and the transition to Brexit is smooth, inflation could ease back towards its 2% target on its own accord.
If it doesn’t, the Bank of England will be there with its wrench to tighten monetary policy. I’ll take it as a sign that Brexit negotiations are going better than many pundits expected.
We’re already seeing a squeeze on real wage growth which, coupled with low interest rates and above-target inflation, isn’t ideal. Any cash kept in a savings account with returns that don’t match inflation will have less purchasing power in the future.
For now, trade figures are improving as businesses look to exploit attractive currency rates. But it all depends on how Brexit negotiations develop over the next two years to whether we’ll be any poorer. Any signs of trouble could see investment dry up, unemployment rise and wages drop.
Painful rate hike
Right now, a rate hike would be painful. With wage growth feeling the squeeze but shop prices increasing, higher interest payments on any debt could prove a bitter pill to swallow.
As a borrower, I’m relieved. But, as a saver, I’m frustrated; it means tolerating measly returns from cash accounts for even longer.
It’s one thing knowing lacklustre rates on cash accounts exist, it’s quite another accepting them as the only option for your savings. Households should put a bit more away at the end of each month, if they can, but the priority is making sure your cash is working harder for you. You don’t want to go through the pain of saving for a life goal to just see your money lose value locked in a savings account.
To navigate any volatility over the next two years, it might make sense for investors to have diversified portfolios that are focussed on the long-term. As long as we’re covered for any rainy day eventuality, our kids future is my family’s priority.