Interesting times
For the last eighteen months we have lived with the extremely low level of interest rates of 0.5%; not since the Bank of England was established in 1694 has borrowing been so cheap – or lending so profitless. The long term “normal” range of interest rates has been 2 to 6%, although clearly there have been lengthy periods when it has been outside these parameters.
The longest period of stable interest rates began with a currency crisis, when the UK left the gold standard in 1932 having been forced to maintain high interest rates during a recession. Interest rates stayed at 2% on an almost uninterrupted basis, until the 1950s, with the only blip being in 1939, with the outbreak of war when the Treasury made the decision to raise interest rates to keep nervous gilt investors on board. Thanks to patriotism and few other options for investors, this turned out to be unnecessary and was swiftly reversed.
The next real shock to interest rates happened in the 1970s, with the advent of high inflation. The root cause of this is usually cited as being the oil crisis – students of economic history are only too aware of the quadrupling of oil prices in the first half of the decade. There are other contributory factors, as is always the case, such as falling productivity in British industry, aggressive trade unions and unaffordable welfare spending. This period of extraordinarily high rates lasted until 1992 when Britain left the Exchange Rate Mechanism. For many of us until that point high inflation and high interest rates had been the norm and adjusting to lower levels has taken time. Even now the expectation is for much higher levels of interest rates, although we should learn some lessons from history: prior to the 1970s, interest rates last reached 10% in the late 1860s.
The situation we now find ourselves in is favourable for borrowers and arguably good for equities too. Yields on cash and bonds are comparatively unattractive and such low costs of borrowing should stimulate corporate activity. While we are seeing some of this come about, there is also weak demand which is the reason interest rates are so low. This is not good for equities. The question on everyone’s lips is when will interest rates rise? This is, of course, impossible to answer. Government spending cuts are deflationary and we are waiting for the spending review next month for clarification on this issue. The emphasis has shifted from inflation management, which has been the central aim of successive governments for some considerable time, to stimulating the economy. Looking ahead, it is hard to see where inflationary pressures may emanate from, unemployment and lack of demand should keep it subdued for the foreseeable future. However, for those who are seeking a better return on their investments, there are still several opportunities available in the stock market: yields of 5 to 6% are readily obtainable in what may be viewed as defensive companies which may also provide the chance to see capital as well as income grow.
Disclaimer
This does not constitute a recommendation to buy or sell investments and the value of any shares may fall as well as rise. Investments carry risk and investors may not receive back the amount invested. The views expressed are those of the author and not necessarily of SWIM.
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