No interest in the credit-crunch?

March 3rd, 2009

On the 5th February 2009, as part of the continued attempts to stimulate the UK’s flagging economy, the Bank of England cut interest rates to 1%, the lowest rate in its 315 year existence and the fifth interest rate cut since October when rates were at 5%.

The interest rate cuts are part of a combination of fiscal and monetary measures (which many will argue have not gone far enough) designed to stave off a deep recession.   The conventional response to falling demand and contracting economic growth is to cut interest rates.  By lowering the cost of borrowing whilst at the same time removing the incentive to save this should, at least in theory, increase demand and consumer spending.  Unfortunately, however we do not live in ‘conventional’ times and this is no ordinary economic crisis.

The real issue is that, despite interest rate cuts, banks are still reluctant to lend – both to each other and to us.  The result is that the impact of the credit crunch is still being  felt in terms of an overall reduction in the supply of money and therefore a downward (deflationary) pressure on prices and output. 
Couple this with a general lack of confidence – worries about job security, an unwillingness to spend unnecessarily – and the effects of this downward pressure are compounded as customers hang on to their money in the anticipation prices will fall further. 

In short, interest rate cuts alone are unlikely to solve the problem and with rates at a record-low of 1% there is very little ‘ammunition’ left here in terms of reducing them further (the US are also experiencing this with rates cut from 1% to just 0.25% in December 2008).  Many economists are also predicting further cuts in the UK with rates possibly falling to as low as 0.50% to 0.25% by the second quarter of 2009.

One of the key issues of falling interest rates is the impact on savers and in particular those who are relying on their savings for income.  Interest rates for the average instant access deposit accounts are now under 1% whilst fixed rate bonds (i.e. notice/term accounts) average around 3%.

Although the prospect looks gloomy for savers there are still term/notice accounts out there paying anything up to 4.5% (gross). In addition it is also worthwhile looking beyond the headline rates at the bigger picture.  Consider interest rates running at 5% (gross) and inflation at 3%:  After taking 20% income tax off your interest and accounting for inflation this gives you a ‘real’ return of just 1% (or 0% for a higher rate (40%) taxpayer).  

If we then consider a scenario where interest rates are only 2% but inflation is zero then, after 20% income tax is deducted, the ‘real’ rate of return is 1.6% (or 1.2% for a higher rate taxpayer).  Despite a significantly lower interest rate the second scenario is clearly better for the saver.

The key is therefore to ensure your savings are beating inflation.  CPI (the official rate of inflation) is currently running at 3% which is still above the official target of 2%, however, with the economy expected to shrink by around 2.8% this year, the Bank of England predicts that inflation could fall well below this target to anything between 1% and zero by 2010 (with some economists even predicting a negative figure – true price ‘deflation’)

It could therefore be argued, against a backdrop of falling inflation, now may be a good opportunity to secure a reasonable savings rate for the next 12 months via a term/notice account which may help to ensure the maximum ‘real’ rate of return, especially as further interest rate cuts are widely predicted during 2009 which can only impact further on the rates available to savers.  In addition it may also be appropriate to consider tax-free vehicles such as a cash ISA as this pays interest gross.

We will be happy to discuss all the options for getting your savings and investments to work as hard as possible in the current climate.

Deposit Protection

Given the recent financial turmoil and adverse publicity regarding banks it is understandable that there are concerns as to the security of any money you may hold on deposit.  Most people are aware that monies held on deposit have some form of protection, but with an ever changing landscape it can be unclear how this protection applies.  This article aims to help clarify the situation.

Since 7th October 2008 the level of protection applying to UK deposit accounts is £50,000.  This is applied per person, per institution so if you have a joint account with a High Street bank showing a balance of, say, £60,000 then each account holder will be deemed to hold £30,000 (unless there is evidence to the contrary) and the full £60,000 is protected.  The protection is provided by the Financial Services Compensation Scheme (FSCS).

The situation becomes more complex when you hold an account with a number of banks or building societies and how the rules are applied will depend on the status of the institution:

  • Where each bank is separately authorised by the Financial Services Authority (FSA) compensation would be paid up to the limit of £50,000 per person, per authorised institution.
  • Where each bank is not separately authorised, but is covered by their parent company’s authorisation compensation would only be paid once, irrespective of how many different institutions a person held accounts with.

Very often it is difficult to know who holds an individual licence, who is covered by their parent company and who is in which group of companies.  This becomes especially difficult with the recent spate of mergers and acquisitions.  The FSA has issued a list of linked deposits for the purposes of the FSCS as at 15th December 2008 and from this some of the main brands covered by the same licence are:

On the 5th February 2009, as part of the continued attempts to stimulate the UK’s flagging economy, the Bank of England cut interest rates to 1%, the lowest rate in its 315 year existence and the fifth interest rate cut since October when rates were at 5%.

The interest rate cuts are part of a combination of fiscal and monetary measures (which many will argue have not gone far enough) designed to stave off a deep recession. The conventional response to falling demand and contracting economic growth is to cut interest rates. By lowering the cost of borrowing whilst at the same time removing the incentive to save this should, at least in theory, increase demand and consumer spending. Unfortunately, however we do not live in ‘conventional’ times and this is no ordinary economic crisis.

The real issue is that, despite interest rate cuts, banks are still reluctant to lend – both to each other and to us. The result is that the impact of the credit crunch is still being felt in terms of an overall reduction in the supply of money and therefore a downward (deflationary) pressure on prices and output.

Couple this with a general lack of confidence – worries about job security, an unwillingness to spend unnecessarily – and the effects of this downward pressure are compounded as customers hang on to their money in the anticipation prices will fall further. In short, interest rate cuts alone are unlikely to solve the problem and with rates at a record-low of 1% there is very little ‘ammunition’ left here in terms of reducing them further (the US are also experiencing this with rates cut from 1% to just 0.25% in December 2008). Many economists are also predicting further cuts in the UK with rates possibly falling to as low as 0.50% to 0.25% by the second quarter of 2009.

One of the key issues of falling interest rates is the impact on savers and in particular those who are relying on their savings for income. Interest rates for the average instant access deposit accounts are now under 1% whilst fixed rate bonds (i.e. notice/term accounts) average around 3%.

Although the prospect looks gloomy for savers there are still term/notice accounts out there paying anything up to 4.5% (gross). In addition it is also worthwhile looking beyond the headline rates at the bigger picture. Consider interest rates running at 5% (gross) and inflation at 3%: After taking 20% income tax off your interest and accounting for inflation this gives you a ‘real’ return of just 1% (or 0% for a higher rate (40%) taxpayer). If we then consider a scenario where interest rates are only 2% but inflation is zero then, after 20% income tax is deducted, the ‘real’ rate of return is 1.6% (or 1.2% for a higher rate taxpayer). Despite a significantly lower interest rate the second scenario is clearly better for the saver.

The key is therefore to ensure your savings are beating inflation. CPI (the official rate of inflation) is currently running at 3% which is still above the official target of 2%, however, with the economy expected to shrink by around 2.8% this year, the Bank of England predicts that inflation could fall well below this target to anything between 1% and zero by 2010 (with some economists even predicting a negative figure – true price ‘deflation’)

It could therefore be argued, against a backdrop of falling inflation, now may be a good opportunity to secure a reasonable savings rate for the next 12 months via a term/notice account which may help to ensure the maximum ‘real’ rate of return, especially as further interest rate cuts are widely predicted during 2009 which can only impact further on the rates available to savers. In addition it may also be appropriate to consider tax-free vehicles such as a cash ISA as this pays interest gross.

We will be happy to discuss all the options for getting your savings and investments to work as hard as possible in the current climate.

FSA authorised institution Main brands covered by this authorisation
Bank of Scotland plc Bank of Scotland
Halifax
Birmingham Midshires
St James’s Place Bank
Saga
Intelligent Finance
Capital Bank
Royal Bank of Scotland plc Royal Bank of Scotland plc
Direct Line (savings only)
Child & Co
Drummonds
The One Account
Lombard
Holt’s
Abbey National plc Abbey National plc
Cahoot
Bradford & Bingley
ASDA
Nationwide Building Society Nationwide
Derbyshire Building Society *
Cheshire Building Society *

* With regard to the merger of the Derbyshire and Cheshire Building Society with the Nationwide, money deposited with each society before the merger is entitled to the same level of coverage after the merger. So, customers with an account at each society will have potential maximum coverage of up to £150,000. (FSCS does not apply to deposits with Cheshire’s Isle of Man branch).

The situation is more complicated where it is an account with a bank from somewhere in the European Economic Area (EU members plus Iceland, Norway and Liechtenstein). Where this is the case the bank may be covered by its home scheme. Schemes in the EU have to offer compensation for at least the first €20,000 (£17,688 as at 20th February 2009 exchange rate), although they may offer significantly more than this. One example of this would be Ing Direct who are covered by the Dutch deposit guarantee scheme. The Dutch scheme covers up to €100,000 per person or per company (limit applies from 7th October 2008 for a period of one year). In addition, they may agree a top up arrangement by which the FSCS would pay the difference between the home scheme’s compensation and £50,000. It is worth checking with your particular provider what the guarantee limit is.

Banks from outside Europe are required to set up a UK subsidiary if they wish to operate in the UK and the subsidiaries have to be members of the FSCS therefore those deposits will be covered.

The Irish Government has decided to fully safeguard all deposits, bonds and debts in six banks and building societies until September 2010. The banks covered are Allied Irish, Bank of Ireland, Anglo Irish Bank, Irish Life and Permanent, Irish Nationwide Building Society and the Educational Building Society. It was announced in January 2009 that the Irish Government is nationalising the Anglo Irish Bank.

In summary, whilst historically the safety of your money with a bank or building society has been unquestionable in today’s uncertain times it is worth checking how much compensation you would get if the bank became unable to meet its liabilities. Where monies are held with different institutions, but with the same licence it may be worth considering moving some to a different provider to protect as much of your money as possible.