The dangers of prolonged low interest rates

The Centre for Economics and Business Research believes that the UK economy has double-dipped back into recession. To pile on the misery, it predicts bank rate will remain at 0.5% until 2016, which would make a total of eight years. Not only this, but it expects the Bank of England to increase its programme of Quantitative Easing from £275 billion to £400 billion this year. This is appalling news for savers, who currently lose £44.5 billion through the gap between inflation and average interest rates.

Not everybody agrees that the Bank of England has got it right, however. We pointed out Anthony Hilton’s article in the Evening Standard which asked whether it was time to think about raising rates. Last week’s minutes of the Shadow MPC revealed that Andrew Lilico of Europe Economics, a former supporter of the Bank’s policy, has changed his mind.

“Current official policy appears to be to try to keep households clinging on, through maintaining policy interest rates at approximately zero, even if that comes at the expense of inflation and significant further deterioration in the value of the pound… It cannot be right to maintain such a policy for more than an emergency period… How long is it morally defensible to protect those that over-indulged and that made mistakes at the expense of those that were more prudent and restrained? A policy that can be perfectly correct if implemented over a year or two years might be the wrong policy if it must be repeated for ten years… There should be a rapid normalisation in interest rates – perhaps to 3.5% over a four- or five- month period.”

The Bank of International Settlements warns of the dangers

The prestigious Bank of International Settlements, the Central Bankers’ bank, also sees dangers in maintaining low interest rates. As we pointed out recently, the BIS reckoned the Bank of England had exaggerated the positive effects of QE. The Annual Reports of the BIS also question low interest rate policies. In June 2010, a section was headed: “Low interest rates: do the risks outweigh the rewards?” … Continue Reading

Are low interest rates the answer – or the problem?

There is a near universal belief among economists, politicians and the public at large that low interest rates encourage economic growth. In the UK, we have had 0.5% bank rate since March 2009 and City economists keep putting back their estimates of when it might rise. The current consensus is that it will not happen until November 2015!

Having painted itself into a corner with interest rates, the Bank of England conjured up Quantitative Easing to further stimulate the economy. QE has not been without its detractors, both for its inflationary impact and because some think it benefits the banks rather than the real economy. The Bank of England admitted that the first bout of QE increased CPI inflation by 0.75% to 1.5%, but claimed that it boosted the economy by between 1.5% and 2%, reducing yields on medium-dated gilts by 1%.

The Bank of England gets its sums wrong

But was the Bank of England right? The Bank of International Settlements – the central bankers’ bank – thinks not. Instead of 5-25 year gilt yields falling by 100 basis points (1%), the BIS believes QE pushed them down by just 27 basis points (0.27%). And while the Bank reckons that the second bout of QE will be as effective as the first, the BIS disagrees: “It may be harder to achieve the same degree of effectiveness as with the initial programmes once the surprise or novelty element wanes”.

We have been arguing that the Bank is not only wrong about QE, but also about the effect of long-term negligible interest rates. On The World at One before Christmas, Bank of England Deputy Governor Charlie Bean was challenged on this. Less fluent than elsewhere, he stammered that, “Had we tried to rein inflation back sharply this year that would have led to too sharp a contraction in activity and what we would also find is inflation dipping well below the target next year.” … Continue Reading

Simon Rose on BBC TV news explaining why interest rates should rise

The Bank of England is killing savers – and the economy

RPI inflation is its highest for 20 years; at 5.6% your money will halve in value in 12 years. CPI has shot up to 5.2%, even though the target rate – ignored by the Bank of England with the complicity of the Chancellor – is 2%. On top of that, we are getting another £75 billion of Quantitative Easing to add to the earlier £200 billion.

The Bank of England is not just failing savers and pensioners; it is failing the country. With no apparent room for manoeuvre on interest rates, the Monetary Policy Committee thinks QE is just the ticket to restore growth to the UK economy. If QE is the answer, why stop at £75 billion? Why not double or quadruple it and really get things humming?

However fancily you dress it up, QE conjures money from thin air to “inject” into the system. The earlier dose of QE did not lead to the hoped-for splurge of bank lending. On the contrary, the banks snaffled the money to rebuild their balance sheets and pay themselves exorbitant bonuses. QE did not spur business investment or improve anything in the “real” economy.

What it did boost was inflation. Even the Bank of England admits that QE has already pushed inflation up by as much as 1.5% and this new tranche will swell it still further. According to one of the Bank’s own leaflets: “It’s the Bank’s job to maintain the value of money by keeping the rate of inflation at a low level.” Yet the more money there is, the less the money that we already own will be worth.

… Continue Reading

Save Our Savers asks the MPC to act to reduce inflation

On Wednesday and Thursday this week, nine grey-suited men will meet at the Bank of England and discuss inflation and interest rates. They are Sir Mervyn King; Charles Bean; Paul Tucker; Ben Broadbent; Spencer Dale; Paul Fisher; David Miles; Adam Posen and Martin Weale.

We can only speculate whether they have a preference for Hobnobs, Digestives or those weird pink wafers you get in biscuit assortment boxes. What we can be pretty certain of, however, is that all but Martin Weal and Spencer Dale will vote to keep bank rate at just 0.5%, as it has remained since March 2009.

The MPC is charged with keeping inflation at the Government’s target of 2%, yet CPI is 4.5% and appears to be heading higher. By our estimate, the real value of the country’s savings has lost over £50 billion in the past 12 months. With an effective transfer of wealth from savers to borrowers, the thrifty and the responsible are involuntarily subsidising the profligate and foolish. As David Cameron said, while in opposition, increasing debt and undermining savings is “both economically stupid and morally indefensible”.

We have written to the nine members of the MPC, highlighting the pain being endured by savers and those on fixed incomes. … Continue Reading

Bait pricing makes suckers out of savers

The majority of savers are allowing inertia to get the better of them – and their savings. A new study from Which? shows that over 60% of savers have not changed their main savings account in the past five years. As a result, they are almost certainly getting an unattractive rate of interest.

According to Paul Davies of Which?: “The average rate for instant access accounts is still only around 0.8% – and our analysis found that 25% of accounts were paying 0.1% or less and 47% were paying 0.5% or less. This equates to £12 billion in interest that savers are missing out on each year.”

The cynical – and yes, that includes us – would argue that is exactly what the banks and building societies want. They pull in vast sums by promoting hugely attractive savings rates, hiding away the fact that they only last for limited periods. 11% of instant-access savings accounts and 14% of instant-access ISAs currently have bonus rates which drop within a year.

The worst offender is The Post Office whose Instant Savers account has a rate that drops from 2.1% to 0.1% after a year, a plunge of 95%. The Post Office is still a trusted brand among consumers but this product’s web page hardly boasts of the 0.1% rate. Others to receive dishonourable mentions are Lloyds TSB, Halifax/BoS, Barclays and Santander. … Continue Reading

Saver shock at retirement

Any insurance salesman will give you the ‘you can never have too much insurance’ patter. While this isn’t technically true, one de facto form of cover has long been wrongly ignored by many retirement savers because of potential cost and opaque information on whether to ‘buy’ it. We’re talking about defined contribution pension pots being ‘fire-proofed’ and the insurable event is inflation, specifically the RPI. Unfortunately, the majority of retirees don’t take out an index-linked pension because the financial hit is so great, yet its implications are far-reaching.

An RPI-proofed policy is the only investment guaranteed to beat inflation for pensioners, yet many prefer not to invest in them.

However, retirees who take out a ‘level’ fixed annuity (or annual income for life in exchange for a lump sum) can be pole-axed by the annual rises in the cost of living. With only a set sum of cash every month, the creeping price of fuel, food, bills et al can clobber the finances over the years. … Continue Reading

The incredible shrinking pound and your savings

It is now widely predicted that the Bank of England will raise the base rate sooner rather than later. Inflation is on the increase and the base rate can’t remain this low for ever, can it?

When Japan reduced its base rate to 0.5% in 1995 nobody expected it to remain at that level or under for the next 16 years, but there it is today at under 0.1%. I’m not saying that our economy is heading the way of Japan’s, just pointing out that the unexpected can and does happen. After all, how many people truly foresaw the banking crisis?

Inflation and the base rate have led us all on a merry dance over the years. In 1980 the base rate reached 17% and inflation peaked at 21%. During July and August 1982 the base rate was being adjusted twice a week in an attempt to meet the economic demands of the moment. In 1990 the base rate rose to 14.88% while inflation stayed below it at 10.9%. The current situation of a base rate being 4.6% below RPI is extreme, but by no means unprecedented. … Continue Reading

If the Bank of England won’t support savers, then the Government must!

We have moved from an era where the ethos of saving was destroyed in the pursuit of economic growth, to one where the rewards for saving are being destroyed in the fight against economic decline.

By financing our economic boom through borrowing, we were in fact paying a premium to the finance industry for the pleasure of instant gratification. The “instant gratification” was mutual; we got what we wanted now, without having to save up, and the finance industry made a profit.

The more we borrowed the more successful they were. So in order to maintain this success they made it easier and more tempting for us to borrow. In any case saving just didn’t seem to fit in the multi-media, online, instant access web-enabled world of the new millennia. … Continue Reading

Are savers being hung out to dry?

What was it that Donald Rumsfeld said? “We know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns the ones we don’t know we don’t know.”

In the recent press conference for the release of the Bank of England’s Quarterly Inflation report, Mervyn King showed a close empathy with Mr Rumsfeld. He very clearly explained what facts that he and the Monetary Policy Committee (MPC) did know and what they didn’t know, as well as what they couldn’t possibly know. The point of this was to stress the uncertainty of factors that the MPC must weigh up in coming to their decision. … Continue Reading