Any respite for savers?

With low interest rates on the cards for some time to come, returns on cash deposit are likely to remain deeply unattractive, particularly given that the spending power of cash is being eroded at a faster rate than for some time. In reality savers are actually losing money by depositing funds in most if not all bank and building society accounts, as the net rate of interest paid is below CPI inflation. If you are going to keep substantial funds as cash, make sure you hunt around for the best rates offered by internet and telephone banks, or new accounts, which often offer incentives for a fixed period of time. Also make full use of any existing or new Cash ISA allowances (see more below). It is also worth bearing in mind that the FSCS compensation limits increased on 31^st December 2010 to £85,000 per person, per authorised Firm. (up from £50,000 per person, per authorised firm previously). For joint account holders, the limit is £170,000. The key point to remember is that this limit is per authorised firm not per account. Also watch for banks which are subsidiaries of others, or trade as a different entity – they may still come under the same authorised firm. If in doubt, check with the deposit taker.

Central Bank Conundrum

The nine member Monetary Policy Committee appear to be divided over the future direction of UK interest rates. Minutes for the February meeting showed three voted to increase rates, with Andrew Sentence recommending a 0.50% increase. Six members voted for no change, and Andrew Posen voted to add additional stimulus into the economy. On the face of things, with Consumer Price Inflation (CPI) running at 4% - double the Bank’s target – the natural reaction would be for the MPC to start increasing rates to bring inflation under control. However, the key fact to consider is that the increasing inflation is due to overseas and external factors that are beyond the Bank of England’s control. Increases in prices within the basket of goods and services that comprise the CPI index have largely been caused by hikes in the cost of raw materials (such as oil, cotton and grains) and increases in taxation (i.e. the recent VAT increase). Companies appear to have, by and large, passed on these increases to consumers. There is very little sign, if any, of wage inflation, which would be far more of a worry to policymakers.

The remit of the Monetary Policy Committee is two-fold – firstly, to aim to keep close to the CPI target of 2%. But secondly, and more importantly, to support Government policy and help meet targets for economic stability and growth. Given the fragile state of the UK economy (as seen by the contraction in the revised 4^th Quarter UK GDP data), I believe that any increase in Base Rates would serve to dampen demand and consumer confidence. However, the inflation hawks will point to the turmoil in the Middle East and the increasing oil price which may well cause inflation to climb even further above the Bank’s target. This may be enough to swing one or two Base Rate increases during the course of this year. However this will only bring the Base Rate back to 0.75% or 1% which is still very low in historic terms.

A Crude Awakening?

I mentioned in my January newsletter that rising oil prices may throw the global economic recovery off course. These comments were written before the tumultuous recent events in Tunisia, Egypt, Bahrain and Libya, which have caused Brent and West Texas Crude prices to spike higher over recent weeks, with West Texas Intermediate Crude rising from $90 a barrel to $101. Speculation that OPEC could not increase production significantly to offset a suspension or severe disruption of Libyan oil production, coupled with fears that uprisings may be felt in neighbouring countries, notably Saudi Arabia or Bahrain, have driven prices higher. Libya is Africa’s third largest oil producer and reports from the International Energy Agency suggest that Libya produced 200,000 barrels of oil less than their usual quota last month.

The surge in oil price has been clearly visible at petrol stations and has led to concern that even higher petrol prices could be on the cards if the turmoil escalates. Chancellor George Osborne has hinted that the 1p rise in fuel duty pencilled in for 1^st April will be suspended, but this will do little to aid motorists who have been hit with three increases in tax (VAT and fuel duty) so far this year.

Whilst the immediate impact on individuals and families who need to spend more at the pumps to fill up is very clear, it is important to consider that the cost of transporting goods to their final destination or point of sale will also increase. The travel industry will also be hit, with some airlines already introducing fare surcharges (although this may have a small silver lining as more people choose to take holidays in the UK, thus boosting our own tourism).

The cumulative effect may well damage the fragile economic recovery and raise inflation higher still, putting further pressure on the Bank of England to raise interest rates (of which more below). Both the British Chamber of Commerce and National Institute for Economic Research have recently reduced their GDP growth forecast for 2011, although both fall short of suggesting the UK economy could be plunged back into recession. I would tend to agree that sluggish growth remains just the most likely scenario for 2011, but the chance of a double dip recession is certainly increasing. And if the price of Brent Crude oil sticks well above the $120 a barrel level for most of the year, the downside risks to growth will only increase.