The Bank of England (BoE) has signalled a potential interest rate cut in August, a big shift in UK’s monetary policy. This move could be the first reduction in borrowing costs in over four years.
During the same June meeting, the BoE’s rate-setting committee voted 7-2 to maintain the current rate of 5.25%, a 16-year high. However, the meeting minutes revealed a notable change in tone, hinting at a possible rate cut at their next meeting on 1 August.
This potential policy shift comes as inflation slowed to 2% in May, aligning with the Bank's target. However, some areas of concern persist, with prices of certain items rising faster than expected.
How Do Interest Rates Change?
Interest rates are a fundamental tool in economic management. They determine the cost of borrowing money and the reward for saving it. The BoE’s base rate influences fixed-interest products and what other banks charge for loans and pay on savings.
When inflation runs high, the Bank may raise rates to encourage reduced spending and curb inflation. Conversely, when inflation is under control, the Bank may cut rates to stimulate economic growth.
How Do Interest Rates Affect Fixed-Interest Investments?
A potential rate cut could have big implications for various fixed-interest products:
Bonds
As interest rates fall, existing government bonds become more attractive, increasing in value. However, new bonds will likely offer lower yields. The same goes for corporate bonds. Companies might also find it cheaper to issue new bonds.
As for Inflation-Linked Bonds, these may become less attractive if inflation expectations decrease alongside interest rates.
Loan Notes
Lower interest rates could reduce the attractiveness of new promissory notes, potentially affecting their terms and conditions. Meanwhile, the property market might see increased activity with lower rates, potentially impacting the terms of property-related loan notes.
Fixed Interest Savings and Certificates of Deposit
Fixed-Rate Savings Accounts: New accounts will likely offer lower interest rates, making existing fixed-rate accounts more valuable.
Certificates of Deposit (CDs): Similar to savings accounts, new CDs will probably offer lower rates. Existing long-term CDs may become more attractive.
Cash ISAs: Returns on cash ISAs may decrease, potentially shifting investor interest towards stocks and shares ISAs.
Looking Ahead
The UK's potential rate cut aligns with a broader trend among major economies. The European Central Bank (ECB) reduced its main interest rate from 4% to 3.75% in June, its first cut in five years.
For investors and expats, these shifts in interest rate policy across major economies present both challenges and opportunities. Diversification across different fixed-interest products and geographical regions may help balance portfolios in this changing landscape. That’s where financial experts at International Wealth Ventures come in.