In a shock move this morning, the Bank of England (BoE) has made an ‘emergency’ interest rate cut, slashing UK interest rates by 0.5% from 0.75% to 0.25%.
The rate cut, which policymakers hope will bolster the economy in the wake of the coronavirus outbreak, means that UK interest rates are back to their lowest level in history again (the same level that rates were cut to in 2016 after the Brexit vote).
Here, I’ll explain what the drop in interest rates means for UK savers and investors.
Bad news for savers
For savers, the rate cut is definitely bad news. Interest rates on savings accounts and Cash ISAs were already abysmally low (well below the rate of UK inflation in many cases), and they’re now likely to drop lower due to the fact that banks use the BoE base rate as a reference point for saving account rates.
At this stage, it’s still too early to know exactly how much the interest rates on savings accounts will fall by. It may take a few days or even weeks for banks to adjust their rates. However, sooner or later, interest rates on savings products will be lowered, meaning savers will receive a lower return on their money.
Of course, if you’ve a fixed-rate savings product, such as a one- or two-year fixed-rate saving account, you’ll be protected from the rate cut, for now. However, when it comes time to renew your savings term, you’ll most likely find the new interest rate is significantly lower than your previous one.
All things considered, it’s a tough time for UK savers at the moment. If your money is sitting in cash savings earning a pittance, you’re likely to be going backwards financially once you factor in the effects of inflation.
Good news for investors
For stock market investors, however, an interest rate cut is generally good news. There are a few reasons why. For starters, lower interest rates are a positive development for most businesses (not banks) as they lower the cost of borrowing. Lower borrowing costs can boost profits, which, in turn, can boost share prices.
Secondly, when interest rates on savings accounts drop, many people look for alternative ways to boost their wealth. The stock market can be a beneficiary. More money flowing into stocks also tends to push share prices up.
Note that both the FTSE 100 and the FTSE 250 indexes are up today on the back of the rate cut.
Finally, when interest rates fall, the dividend yields offered by stocks become more valuable. For example, if savings account interest rates drop from 1% to 0.5%, a 3.5% yield from a high-quality FTSE 100 stock such as Unilever suddenly looks even more attractive. Again, this can push share prices higher, due to higher demand for dividend stocks.
So, while today’s BoE interest rate cut is disastrous news for cash savers, it’s not bad news for everyone. If you’re invested in the stock market, there’s a chance you could benefit.
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Edward Sheldon owns shares in Unilever. The Motley Fool UK owns shares of and has recommended Unilever. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.