Although the current low-interest-rate environment is incredibly painful for savers, the reality is that UK interest rates are highly unlikely to rise at a rapid rate in the coming years. In fact, it would be of little surprise if they were still well short of their 4% or 5% historic ‘norm’ by the end of the current Parliament in 2020, since there’s little to indicate that a higher rate is required.
A key reason for that is stubbornly low inflation. Although the UK economy has performed well relative to its developed peers in recent years, the slowdown in China has caused deflationary pressure across the globe. This is perhaps the Bank of England’s biggest fear, since deflation is notoriously difficult to overcome. It can cause consumers to spend less, the economy to fall into a recession and would probably require major stimulus to overcome.
Therefore, with inflation being near-zero, deflation is still the biggest risk facing the UK economy. And with higher interest rates having the effect of cooling economic activity and inflation, a rise in interest rates could cause the mildly positive inflation numbers of late to slip into negative territory.
Furthermore, the Monetary Policy Committee (which decides UK interest rate levels) will have noted the market’s reaction to the US Federal Reserve’s decision to raise rates in December. It had planned as many four further rate rises this year, but now may only implement one or even none, such has been the negative reaction by investors. It seems likely that the Monetary Policy Committee will be extremely cautious regarding rate rises and will not increase them until it’s sure the market is ready to accept them.
High-yielding stocks
As a result of a lack of interest rate rises, cash balances are unlikely to yield an appealing return over the medium term. Fortunately for income-seekers, there are a number of high-yielding stocks on offer at the present time. They could become popular in future years, not only because of the potential for sustained low interest rates, but also because the outlook for the global economy is highly uncertain. This could make investors seek out more stable, defensive companies that tend to be the more appealing yield plays.
For example, China continues to transition towards a consumer-focused economy and this could continue to be a less-than-smooth change. Also, the US is due to elect a new President later this year and alongside the potential for further challenges in the EU and a Japanese economy that has a major demographic headwind, investors could become increasingly ‘risk-off’ in the next few years. As such, dividend shares could benefit from improving investor sentiment towards them, and their capital returns may end up being ahead of the wider market.
Clearly, there’s more to investing than dividends, but a company that offers a relatively appealing yield plus the potential for dividends that increase at a rapid rate is likely to be popular whatever the economic conditions. With there being a number of challenges on the macroeconomic horizon, the prospects for dividends appear to be exceptionally bright at the present time.
