Investors Should Prepare for Interest Rate Cuts

Gilt yields have turned negative in the UK following a speech from Bank of England Governor Mark Carney hinting at an interest rate cut this summer

Emma Wall 1 July, 2016 | 11:15AM
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This was supposed to be the season savers finally got respite from the seven years of record low interest rates in the UK. Borrowers were poised for the cost of debt to rise, and income investors were looking forward to finally gaining a yield on cash deposits. 

But then we had the Brexit vote – and now all bets are off. Last night, Bank of England Governor Mark Carney sought to ease economic concerns post-Brexit in his second speech since the referendum result was revealed last week. Speaking to business leaders in London, Carney hinted that there could be an interest rate cut this summer, an about-turn from expectations earlier in the year that the UK would raise rates in 2016.

Carney said that uncertainty over the scale of the changes following the Brexit vote “could weigh on our economic prospects for some time”, but that the Bank would not “shirk from its obligations”.

“I want to re-emphasise that the Bank has taken all the necessary steps to prepare for these events. And we will not hesitate to take any additional measures required to meet our responsibilities as the United Kingdom moves forward,” he said.

“As the MPC said prior to the referendum, the combination of these influences on demand, supply and the exchange rate could lead to a materially lower path for growth and a notably higher path for inflation than set out in the May Inflation Report. In such circumstances, the MPC will face a trade-off between stabilising inflation on the one hand and avoiding undue volatility in output and employment on the other.

“The implications for monetary policy will depend on the relative magnitudes of these effects. In my view, and I am not pre-judging the views of the other independent MPC members, the economic outlook has deteriorated and some monetary policy easing will likely be required over the summer.”

Gilt Yields Go Negative but Stocks Rally

Following Carney’s speech, sterling fell against the dollar and gilt yields entered negative territory in anticipation of a rate cut.

Gilts maturing in March 2018 were yielding -0.04% on Friday morning, joining Germany, Austria, the Netherlands, Denmark, Switzerland and Japan in offering negative yields on government bonds. In contrast, UK stocks rallied, with the FTSE 100 up 25 points on Friday morning.

Long Term Effect of Brexit on Savers

Carney also took the opportunity to warn against the long-term effects of an economic slowdown, saying that there was a risk of warping the personal finances of a generation permanently.

“Research has shown that people who have experienced low returns throughout their lives, like the ‘Depression Babies’ of the 1930s, report lower willingness to take financial risk, are less likely to participate in the stock market, invest a lower fraction of their assets in equities, and are more pessimistic about future returns,” he explained.

“Today, uncertainty has meant an inchoate sense of economic insecurity for many people despite generalised economic prosperity. Across the advanced economies, employment appears less secure, wages more subdued, and inequality more pronounced.”

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

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About Author

Emma Wall  is former Senior International Editor for Morningstar