Why Interest Rate Rises Won’t Hurt High-Yield Shares

Graph showing the FTSE 100 index and FTSE 100 dividend points from October 1999 to October 2013Bank of England Governor, Mark Carney, surprised many investors with his Mansion House speech, where he hinted that interest rates could go up as soon as this year. Indeed, many investors had expected him to wait until after the General Election in 2015 before increasing rates from their historic lows of 0.5%.

In terms of the effect on the stock market, a rise is usually not good news. That’s because (in theory) there is less incentive to invest versus save and it could be argued that high-dividend-paying shares such as GlaxoSmithKline (LSE: GSK) (NYSE: GSK.US) and Imperial Tobacco (LSE: IMT) could be hit harder as demand for a higher yield declines. However, that may not hold true over the next few years. Here’s why.

High Yields Will Still Be High Yields

Partly as a result of interest rate rises starting from such a low base (a historical low of 0.5%), they will have to increase by a very high multiple before they begin to look attractive to investors. In other words, a 1% rate of interest may be twice as attractive as 0.5%, but is still below inflation and therefore very unattractive. As such, even if interest rates are doubled, trebled or quadrupled, they may not cause a vast number of investors to suddenly sell shares in GlaxoSmithKline and Imperial Tobacco and instead open savings accounts.

Furthermore, the rate at which interest rates are likely to rise may be somewhat pedestrian. In other words, the credit crunch is a very recent memory for the Bank of England and it may be unwilling to take a gamble on choking the UK’s current economic recovery. As a result, interest rates are unlikely to swiftly move the 5%+ level that was in place prior to the credit crunch, meaning high yielding shares are likely to remain attractive over the medium term.

Two High-Yielding Shares With Strong Prospects

When it comes to high yields, they don’t come much higher at present than GlaxoSmithKline and Imperial Tobacco. Both companies are in the top 15 highest-yielding FTSE 100 companies and currently offer yields of 4.8% and 4.4% respectively. Furthermore, dividends are well covered and are set to increase at an attractive pace in the coming years, thereby helping investors in the two companies to stay one step ahead of interest rate rises (whenever they may eventually come).

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Peter owns shares in GlaxoSmithKline. The Motley Fool has recommended shares in GlaxoSmithKline.