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Five years at 0.5% - the winners and losers
They said it was temporary, but five years later interest rates are still stuck at 0.5% with no sign of them going up anytime soon. We take a looks at the biggest winners and losers after half a decade of the lowest interest rates in history.
The market has come to expect Bank of England meetings to be rather dull affairs, however, this week’s meeting marks an important anniversary, it’s the 60th meeting when rates have been at 300-year lows of close to 0%.
With no sign of the Bank hiking rates in the near-term, what has been the effect of half a decade of low rates on our economy and is it a good or bad thing?
The answer is that it is both, which side of the fence you fall on is likely to depend on your age and your income.
The biggest losers - The retired
Firstly, let’s looks at pensioners, who have been vocal in their opposition to low rates. Let’s take a pensioner who is living on a state pension as well as their savings. Since the state pension is meagre they may need to rely on their savings to supplement their income. The trouble is that with rates so low pensioners are only making miniscule returns on their savings, and their money is actually losing value, since the rate of inflation is still above interest rates.
The second way that low rates hurt pensioners is through annuities. An annuity is financial contract where the buyer pays a lump sum, and the seller, usually a life insurance company, makes a series of future payments to the buyer. Think of an annuity like a mortgage in reverse, as the buyer you want the highest possible rate so that your payments will be larger going forward.
However, since annuity rates are based on Government bond yields, which are impacted by Bank of England base rates, annuity rates have been dismal in recent years, which can seriously impact quality of life for today’s pensioners.
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Winners - Future pensioners
For tomorrow’s retiree record low interest rates may be something of a blessing. Those who are currently saving into a pension plan, especially younger people, will probably find their pension plans are heavily invested in stocks, which have risen significantly during the last five years.
The FTSE 100 was trading around 3,500 five years ago, today it is nearly double that at 7,000. While it is true that the UK index follows the US index closely, and US stock index gains have been put down to the US’s Federal Reserve’s enormous quantitative easing programme, the Bank of England hasn’t boosted its asset purchases since mid-2012, yet UK stocks have continued to rise, which suggests that low interest rates could have some link to rising equity prices.
Homeowners are winners too
Although some pensioners will have lost out in annuities and savings income, others have made large gains in their housing equity during the recovery, especially pensioners who are home owners in the South East. The average house price in greater London is now £541,313, according to UK Rightmove, up from £380k in mid-2008.
So some pensioners may be poorer in cash terms, but those who are on the property ladder may have seen their asset values shoot up as a result of low interest rates.
A long term chart of house prices show that they always tend to appreciate in value over time, however, it is the pace of appreciation in the last five years that has been astounding, which can be partly attributed to record low rates.
Losers the young
A lot of the criticism of low rates has centred around the impact on pensioner; however, young people have also been negatively affected by low rates. The number of first-time buyers has fallen to its lowest level since records began, as house prices rise, wages stagnate and gathering deposits big enough to get a mortgage becomes a monumental task.
This hits young people, who make up the bulk of first-time buyers, and could delay a whole generation from getting on the property ladder. Only time will tell what the social impact of this could be.
Overall, both pensioners and young people have been winners and losers, so in reality it is like swings and roundabouts, you gain some, you lose some.
The real test for the Bank will be how it can normalise interest rates without triggering a housing and stock market sell-off. This is some way off as the market is not expecting the first 0.25% rate rise until well into 2015.
A period of low rates in the US after the dotcom bubble burst in 2002 was blamed for sowing the seeds of the sub-prime crisis in 2008; right now we are in a blind spot. Record low rates have had both good and bad effects that, for now, are cancelling each other out. Whether or not this triggers the next crisis down the line, we shall have to wait and see, but it’s unlikely to be another 5 years.
Kathleen Brooks is author of Kathleen Brooks on Forex, published by Harriman House.
