For almost everyone in the UK, the question of when interest rates will rise has dominated 2015. In fact, it is becoming a rather frustrating topic to consider, since the Bank of England seems to be somewhat hot and cold regarding the idea of raising rates, with it seemingly keen at one moment before kicking the idea into 2016.
Realistically, interest rates are unlikely to rise at a rapid rate for some time. Certainly, they are unlikely to remain at 0.5% for another twelve months, but equally it is unlikely that they will be anything near normal even in a handful of years’ time (i.e. at 4% — 5%). That’s because the global economy is in a deflationary period and, with the Chinese economy now enduring lower growth than was previously anticipated, it seems likely that inflation in the UK will remain rather low.
As a result, the Bank of England has less scope to raise rates, since it is fearful of deflation above most other economic challenges. Therefore, high yield stocks are likely to remain very popular over the medium to long term, with Barclays (LSE: BARC) set to benefit from continued investor interest in companies that pay generous dividends.
Of course, Barclays has not been a top notch income stock in 2015. It is expected to yield just 2.5% in the current financial year, which is well behind a large number of its index peers. However, Barclays’ dividend is likely to increase at a rapid rate over the medium to long term, with the bank being expected to yield as much as 3.4% in 2016.
While higher, a yield of 3.4% is still not particularly appealing at a time when a number of oil and mining majors are yielding well over 6%. However, Barclays is likely to increase dividends significantly over the medium to long term as a result of a combination of increasing profitability and a rising payout ratio. Key to this is the improving performance of the UK economy which, despite global challenges, is exceptionally resilient and is creating the ideal conditions for banks such as Barclays to flourish. As a result, Barclays is expected to increase its bottom line by 36% this year and 21% next year – with more growth likely to come in future years.
In addition, Barclays is likely to increase its payout ratio. It currently stands at just 29% but, given that its outlook is positive, paying out 50% of profit as a dividend would be very affordable and allow Barclays to reinvest sufficient capital into its business. A payout ratio of 50% would equate to a dividend yield of 5.3% in 2016 and, while it may take time for Barclays to reach that level of dividend payout, over the medium to long term it is well within its capabilities.
Looking ahead, Barclays is likely to undergo a period of intense change. A new CEO may not be appointed until 2016 but, with the bank’s financial performance being strong and its operating environment improving, it seems destined to become a top notch income play over the medium term.