What’s happening with interest rates?
By Paul Montague, Partner, Blevins Franks
928 433 411 | canaryisles@blevinsfranks.com | www.blevinsfranks.com
Central bank interest rates in the UK and EU increased at a rapid pace over 2022 and 2023 to combat escalating inflation following the pandemic and the invasion of Ukraine. Now that inflation has decelerated and stabilised in many countries, interest rates are returning to more neutral levels.
Falling interest rates benefit borrowers and can boost economic growth, equities, bonds and property markets, but cash savers will earn lower returns from bank accounts.
UK interest rates and inflation
The Bank of England cut its interest rate from 4.25% to 4% in August, the fifth cut since August 2024 and the lowest rate in over two years. Rates were then left unchanged at the Monetary Policy Committee’s September meeting, although two of the nine members voted for a quarter-point reduction to 3.75%.
Policymakers are concerned about persistent inflation, but also has to balance this risk against
weak economic growth and the slowdown in the job market.
The Bank of England base rate had remained close to zero (0.1% to 0.75%) from 2009 through to the end of 2021. The rate then increased to contain high inflation, reaching 5.25% in August 2023. Once inflation levels improved, the BoE began to reduce its interest rate again. However, while the UK Consumer Price Index is now much lower than its 2022 peak of 11.1%, July and August’s 3.8% is well above the Bank’s 2% target.
Following the MPC meeting on 18 September, Bank of England governor, Andrew Bailey, said: “Although we expect inflation to return to our 2% target, we’re not out of the woods yet so any future cuts will need to be made gradually and carefully.”
European Central Bank and EU inflation
The European Central Bank has cut its deposit rate eight times since June 2024, reducing it from 4% to 2%. The last cut was made on 11 June this year. The ECB main financing operations and main lending facility rates were also cut to 2.15% and 2.4% respectively in June.
These cuts reflect the lower inflation levels the EU is experiencing. The Eurozone average was 2% in August (measured by the Harmonised Index of Consumer Prices). HICP was 2.7% in Spain and Malta, 2.5% in Portugal, 0.8% in France and 0% in Cyprus.
The ECB September press release confirmed that the Governing Council is “not pre-committing to a particular rate path”. Decisions will be based on assessments of the inflation outlooks, economic and financial data, and the strength of monetary policy transmission.
What does this mean for the economy, investors and savers?
Lower interest rates are generally seen as a positive development for economic activity and growth.
As the cost of borrowing falls, governments, companies and individuals can access funds more affordably, which generally leads to increased economic activity, growth, jobs and wealth. If a company can borrow funds more cheaply, it is more likely to pay down its debt, invest, create jobs and grow. This usually leads to a rise in stock markets and, since bond markets typically have an inverse relationship with interest rates, bond prices can rise as interest rates fall. Cheaper mortgages also stimulate property markets.
A diversified investor with exposure to equities, bonds and real estate could really benefit from falling interest rates if this leads to higher portfolio values.
On the other hand, as the cost of money is cheaper and generally more abundant, savers are put at a disadvantage as the interest they earn on bank deposits falls in line with central bank interest rates.
Cash deposit risks
When evaluating your investment returns, what is important is the real returns after accounting for inflation and tax.
Inflation is a ‘silent risk’, especially for those who keep much of their savings in the bank. For example, if your deposit account pays you 2%, but inflation is running at 4%, your purchasing power is shrinking every year. Your balance may look safe but, in real terms, your savings are losing value – and this catches retirees out all too often.
Many people also underestimate how of their interest earnings are lost to tax. For example, it is a flat 30% in France, 19-30% in Spain and 28% in Portugal.
So not only could your cash deposits struggle to keep pace with inflation, but a good slice of the interest you do earn is taken away in tax. Your net return can be extremely modest and sometimes close to zero in real terms.
One final risk is protection – what happens to your savings if the bank holding your money fails? This risk may seem quite remote, as memories of the 2008 bank crisis fade away, but it is worth being aware of.
The EU and UK do have deposit guarantee schemes in place, but it is limited to €100,000 (£85,000) per person. This is not per bank account or even per bank, but per banking institution. If you’ve built up a sizable nest egg and hold it all with one institution, anything above that amount is essentially unprotected if the bank were to fail.
Your savings
It is of course absolutely sensible to keep some money on deposit. You’ll always want easy access to cash for day-to-day needs and emergency funds should you need them. However, relying heavily on it for retirement income carries some real risks. The erosion of value through inflation and tax all add up and there is the lack of full protection.
This is why it is important for retirees to review their income strategy and explore whether a more balanced, tax-efficient option could provide better long-term returns and higher levels of security.
The smarter approach is diversification – spreading your wealth across different types of investment assets rather than leaving it all sitting in the bank. You can balance risk and return by holding a mix of assets such as equities for growth, bonds for stability and perhaps some alternative investments too.
Importantly, you can do this in a way that shelters your earnings from tax. Countries like France, Spain, Portugal and Cyprus offer investment structures that not only provide access to a broad and well-diversified portfolio, but also offer real tax advantages. They can allow income and gains to roll up tax deferred, reduce your effective tax rate when you make withdrawals, and significantly improve the way your wealth is passed down to your heirs.
Depending on the jurisdiction these arrangements are held in, they can also offer a much higher level of investor protection than banks can. For example, Luxembourg provides very robust protection for life assurance policyholders. If you have an investment bond issued by a Luxembourg regulated insurance company, your investment assets are protected should the insurance company fail.
Having the right wealth manager and the right strategic financial plan in place can provide peace of mind, estate planning advantages and reap financial rewards.
These views are put forward for consideration purposes only as the suitability of any investment is dependent on individual circumstances; take individual personalised advice. The value of investments can fall as well as rise as can the income arising from them. Past performance should not be seen as an indication of future performance.
Summarised tax information is based upon our understanding of current laws and practices which may change. Individuals should seek personalised advice.
Blevins Franks Wealth Management Limited (BFWML) is authorised and regulated by the Malta Financial Services Authority, registered number C 92917. Authorised to conduct investment services under the Investment Services Act and authorised to carry out insurance intermediary activities under the Insurance Distribution Act. Where advice is provided outside of Malta via the Insurance Distribution Directive or the Markets in Financial Instruments Directive II, the applicable regulatory system differs in some respects from that of Malta. BFWML also provides taxation advice; its tax advisers are fully qualified tax specialists. Blevins Franks Trustees Limited is authorised and regulated by the Malta Financial Services Authority for the administration of trusts, retirement schemes and companies. This promotion has been approved and issued by BFWML.
