Since 5 March 2009 the UK interest rate has stood at just 0.5%. That’s the lowest in history and when it was reduced to such a level, few investors or commentators thought that over seven years later it would still be at an all-time low. However, today the Bank of England announced that interest rates are being kept at 0.5% and in fact, discussion seemed to be more focused on whether they will fall rather than rise.
That’s because the EU referendum is now just around the corner and the Bank of England is somewhat concerned about the potential effect of a Brexit. The Bank stated that it could cause a recession, with such a situation seemingly likely to mean continued low rates. And as well as those low rates, other tools such as quantitative easing may also be used to help the UK economy to recover from what could prove to be a challenging period.
Of course, a Brexit could also cause the value of sterling to fall, with the currency’s weakness in recent months arguably being indicative of what a Brexit could mean for it over the coming months. In such a situation, imports would become more expensive and this could cause inflation to rise, thereby meaning that a higher interest rate may be required in order to combat rapidly rising prices. Therefore, stating that interest rates will stay low if Britain exits the EU may not be a simple forecast to make.
The inflation factor
Clearly, the effects of a Brexit are impossible to accurately predict. However, with inflation being only just above zero for a prolonged period, there seems to be little need from a price level perspective to raise interest rates. In other words, interest rates are only usually increased to cool off an overheating economy, with a high inflation rate being indicative of such a situation. Therefore, unless inflation moves substantially higher, then low interest rates may be here to stay over the medium term.
While the UK economy has improved significantly in recent years and has posted strong growth numbers, the decision as to whether or not to raise rates still seems to be much more dependent on inflation. Therefore, rising employment and improving GDP figures may not be enough to sway the Bank of England towards raising rates – unless they’re combined with modest levels of inflation.
Similarly, with the credit crunch still being a relatively recent event and uncertainty surrounding the global economy being high, the Bank of England may understandably be cautious about choking off the UK’s economic recovery. As a result of this, savers may be in for a tough time in the coming years, since even if rates are raised they’re likely to be increased at a relatively slow pace.
So, while interest rates have been low for a very, very long time, their increase still seems to be impossible to predict. That’s why buying high yield shares could prove to be a sound means of making up for a lower income from cash balances.