Yesterday, the Bank of England (BoE) decided to keep the main interest rate unchanged at 0.1%. The most recent cut had been on 19 March, when the BoE had lowered it from 0.25%.
As I write, broader markets in the UK are mostly flat. And many investors are wondering what ongoing low interest rates may mean for their portfolios. Therefore, I’d like to discuss the potential effect of BoE’s interest rate decision on the FTSE 100 index.
Low interest rates are the norm
The BoE website details the progressive decline of interest rates over several decades. As you can see, 0.1% is a record low. Many economists would agree that it’s practically zero to all intents and purposes.
Interest rate decisions affect the cost of mortgages, credit cards and other borrowings for both individuals and businesses. Typically, lower interest rates count as good news for stock markets. In other words, there’s an inverse relationship.
For example, legendary investor Warren Buffett believes stocks outperform all other asset classes over the long term, especially when interest rates and corporate tax rates remain low.
Low rates aim to add stimulus to our economy. They usually trigger mortgage, car and personal loan rates to fall. They make it cheaper for consumers to borrow money.
British businesses may also find it easier to fund new investments. Many companies like utilities, such as National Grid and SSE, and telecoms firms, such as Vodafone or BT Group, tend to carry high levels of debt on their balance sheets. Therefore, lower rates may mean a boost to their bottom lines.
And the pound?
When the BoE cuts rates, the pound is usually devalued against other major currencies, such as the US dollar or the euro.
Most FTSE 100 companies are multinational conglomerates. Up to three-quarters of their revenue comes from overseas. When the pound is low against, for example, the US dollar, this may impact UK businesses that generate income in dollars. The dollars they’re earning outside the UK now become worth more pounds. This, in turn, leads to a potential increase in profitability.
For US consumers, British goods would also become less expensive. Thus, UK exports may increase overall. That said, a weaker pound makes imported raw materials more expensive. And the increased costs eventually get passed down to the consumer.
However, other central banks globally have also been cutting interest rates in recent weeks. Therefore, the overall effect of low interest rates in the UK on the value of the pound may not be so clear cut.
FTSE 100 shares with the highest non-UK revenue come from various industries. They include miners, industrials, oil companies and pharmaceuticals. Fresnillo, Rio Tinto, BHP, BP, AstraZeneca, GlaxoSmithKline, and Smith & Nephew are examples.
Foolish takeaway
My strategy now? I’d carry on investing in strong companies that also pay dividends. Instead of a Cash ISA, I’d consider a Stocks and Shares ISA. No bank account will likely offer anything close to a real rate of return in the near future. Thus dividend shares could be a good option for income investors.
I’d also watch out for short-term price dips to buy more. In the FTSE 100, I’d consider investing in several companies, especially if there is further weakness in their share prices in May. They include BAE Systems, Berkeley Group, Coca Cola HBC, Diageo, Tesco, and Unilever.
