Key points

  • Interest rates will rise gradually and peak at much lower levels than in previous economic cycles
  • This reflects the scale of the debt burden; the fragile nature of the economic recovery; and the absence of inflation
  • Several central banks have increased rates in developed economies since 2008 and been forced to backtrack
  • In this environment, the hunt for income will remain as intense as ever

Savers hoping that deposit rates and gilt yields will return to levels seen prior to the global financial crisis are likely to be disappointed, says Nick Samouilhan.

Interest rates may have finally risen in the US, but seven years on from the global financial crisis (GFC) gilt yields and UK deposit rates have yet to recover to their pre-crisis levels. The last time average one-year cash ISA rates exceeded five per cent was in February 2008, according to the Building Society Association. As of October 2015, the average ISA rate stood at 1.39 per cent. Meanwhile, the last time ten-year gilt yields topped five per cent was in June 2008. They currently stand at well below 2 per cent.

It wasn’t supposed to be this way. When the Bank of England cut interest rates to 0.5 per cent in March 2009, it was widely believed that this would be a temporary measure. It was a similar story in the US. The Federal Reserve (Fed) cut rates to close to zero in December 2008. By the end of 2009, some of the more hawkish rate-setting officials at the Fed were already anticipating a rise in interest rates.

Yet expectations of when rates will go up have been pushed back every year since. Furthermore, there is no guarantee a central bank will be able to hold a steady course on rates after the first increase. Several central banks in ‘developed’ nations have tried since the crisis, and all have subsequently been forced to retreat. The Reserve Bank of Australia (RBA) is a case in point. Having joined its peers in easing policy as an immediate post-crisis remedy, the RBA attempted to swim against the tide by raising rates from a low of three per cent in April 2009 to 4.75 per cent in November 2010. A year on, with the euro-zone crisis in full swing, the RBA was forced to reverse course. Its policy rate is now down to two per cent, a historical low.

The ECB and various other European central banks, including those of Sweden and Denmark, have negative interest rates, with banks charged to leave funds on deposit with the central bank.

This could happen in the UK. In September 2015, the Bank of England’s chief economist Andy Haldane said rates could, if required, fall even further to combat low inflation, and went as far as to suggest negative interest rates could, if necessary, be introduced to stop people hoarding cash. However, while central bankers such as Haldane would be failing in their duty if they did not consider all the options, Mark Carney, the governor of the Bank of England, later said he did not see any need for negative interest rates.

The interconnectedness of the global economy is one reason why policymakers’ efforts to raise interest rates have been continually postponed in recent years. In the summer of 2015, political turmoil in Greece and then a slump in Chinese equity prices spooked the Fed into inaction. “These should not be seen as independent events, as lightning bolts from the blue. Rather, they are part of a connected sequence of financial disturbances that have hit the global economic and financial system over the past decade,” said Haldane.

It is also illustrative to examine the impact of the extraordinary reflationary policies that have been implemented by central banks in the post-GFC period. Trillions of dollars have been released through `quantitative easing` at the same time as interest rates have been pressed to the floor. Despite these measures, global economic growth has slowed every year since 2010, according to the International Monetary Fund, and deflation still seems more of a threat than inflation.

In short, the GFC left the world in a precarious position from which a slow recovery was always likely. For the sake of their own credibility, there are good reasons for central banks including the Bank of England to raise rates. But given the scale of the debt burden, the fragile nature of the economic recovery and the absence of inflation, rates are likely to rise more gradually, and peak at much lower levels, than their historical norms.

Important Information

Unless stated otherwise, any sources of all information is Aviva Investors Global Services “Aviva Investors”) Limited as at 05 January 2016. Unless stated otherwise any views and opinions expressed are those of the author and should not be viewed as indicating any guarantee of return from an investment managed by Aviva Investors nor as advice of any nature. The value of an investment and any income from it may go down as well as up and the investor may not get back the original amount invested.

RA15/0896/310316.