16th September, 2016

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A New Found Interest in Interest

For the first time in years, Grandma Harrison parked the standard opening lines of conversation; “So how’s work? Are you eating properly… of course you are, look at the size of you!”, in exchange for a thrilling discussion about Mark Carney’s (Governor of the Bank of England) decision to cut UK interest rates from 0.5% to 0.25% in August this year.  Her main area of interest was how the changes were having an effect on the cash deposits she was holding with the bank.

Following this conversation, two main things dawned on me; firstly, the sheer fact that my gran, who has historically been somewhat oblivious to changes in monetary policy, was suddenly taking an interest (excuse the pun); and secondly, it highlighted how confusing current economic uncertainty can be for someone who has been able to enjoy relatively stable returns on her cash savings, for the majority of her life.

The shifts in public attitudes and behaviour are perhaps more interesting than the rate change itself.  From the general realisation that very few banks continue to reward customer loyalty, which has led to an increase in frequent bank account changes over the past few years, to an increased political interest that may have contributed to the rise of Trump and Brexit.

Interestingly, Mr Carney’s decision came just a month after Brexit, and sparked a degree of controversy for being a relatively bold call, in an extremely uncertain period.  In simple terms, changes in interest rates are used as a tool to alter behaviour and ‘manoeuvre’ the economy.  An interest rate reduction theoretically has two main effects:

  • The incentive to save is reduced: Individuals start to receive a lower return on their cash savings.  Such a reduction should encourage people to spend and contribute to the economy; and
  • The cost of borrowing is reduced: Lower interest rates reduce the cost of debt (e.g Mortgages), which in-turn increases the level of consumer spending and corporate investment.

As far as cash accounts are concerned, we are starting to see the recent rate change passed onto consumers by the banks. Typical AER (annual equivalent rate) on an instant access savings account is 1%* increasing to 2% on fixed term deposits**.  With CPI (Consumer Price Index) Inflation at 0.6%, the ‘real’ return is much lower.

As rates continue to worsen from dismal to abysmal one question remains; “If not cash, where?”.  In times of uncertainty, the need for advice has never been more crucial.  As for my gran’s desire to “escape” from her “appalling” cash ISA rates; she has been in contact with her advisor, and feels much better for it.

Source: Moneyfacts 7 Sept 2016, *based on a 50 year old holding £10,000 on instant access (variable rate) **50 year old holding £10,000 on a 5 year fixed rate bond.  Rate before tax.  All rates are subject to change without notice.