Are low interest rates the problem, not the solution?
18 February 2016
All of us involved in producing
illustrations for pension scheme members
have both a statutory duty, demanded of
us by Statutory Money Purchase
Illustrations (SMPI) rules, as well as a
fiduciary responsibility to ensure that
we use both prescribed and sensible
growth projections.
However the
prolonged period of low interest rates
being dictated by The Bank of England,
gives us something of a challenge. Cash
funds are earning next to nothing, and
in some cases are delivering negative
returns after charges are taken into
account. Equity markets have enjoyed
quite a bull run as they recovered from
the 2008/9 crash, but now seem to have
run into choppy waters. Should we
project forwards assuming that customers
will earn no interest and achieve no
growth on their savings? Surely not,
that’s just too awful to contemplate!
We can understand something of what’s been going on by
following the money trail. The Bank of England has been
doing two things: it’s been keeping short term interest
rates low and using its newly printed QE money to buy
gilts off other investors, driving down the long term
rates as well.
So there is lots of money
available for companies to grow their businesses, and
they can get it at unbelievably low cost. At the risk of
upsetting the CEO’s of all major companies, we should
have realised that all this free money would lead to
over-production. Milk prices have fallen because we make
too much milk. And the same for steel. And also for oil
and gas, where all that money spent on developing
fracking technology has resulted in an oil glut that has
collapsed the oil price and means the port of Aberdeen
is now clogged with oil rigs towed back to shore as
nobody wants the North Sea oil they were supposed to
pump out.
Simplistically, we might think that
falling prices are good news for the consumer. It’s
certainly nice to have to spend less to refill the
petrol tank at the end of the week. But the longer term
consequences of this overproduction are not nice, and
they came home to me on reading Shell’s recently
published annual results.
Shell’s return on
capital employed during 2015 was just 1.9%. As an
investor, I find that’s shockingly low. My tracker fund
certainly holds Shell, and maybe my active managers do
too. If all equities earned that, and we produced
pension illustrations showing growth funds earning 1.9%
and cash funds earning nothing, well I think customers
would pretty soon stop saving!
There is no end to
this in sight. The Bank of England’s Monetary Policy
Committee has just voted 9-0 to keep interest rates on
hold. And their Inflation Report notes that investment
by business has been “significantly faster”
It’s
time we called for higher interest rates. Only a higher
cost of capital will make companies stop and think
whether what they are investing in is really needed.
Cheap capital means that all sorts of weak projects get
approved, producing output that isn’t needed, further
depressing prices. That sort of behaviour by companies
is destroying investors’ money
Maybe the Bank of
England have got it wrong. Their ultra-low interest
rates are not solving a problem, they are the problem!
It’s time to increase rates, in baby steps, to get us
back to normal rates of return and enable us to generate
pensions illustrations that show a decent rate of return
and a fair reward for those doing the right thing and
saving for their future.
Adrian Boulding is
Retirement Strategy Director at Dunstan Thomas.
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