2024 is expected to be a year that interest rates across the globe will fall, after two years of sustained increases by central banks. This trajectory, and the inevitable “how far and fast” debate, invites numerous questions as to the state of the economy – both in the UK and globally. Clients and advisers should also take this opportunity to consider other correlated risks, such as counterparty and liquidity risk.
This article therefore seeks to shed some light on what’s to come in this calendar year.
2024 is expected to be a year that interest rates across the globe will fall, after two years of sustained increases by central banks. This trajectory, and the inevitable “how far and fast” debate, invites numerous questions as to the state of the economy – both in the UK and globally. Clients and advisers should also take this opportunity to consider other correlated risks, such as counterparty and liquidity risk.
This article therefore seeks to shed some light on what’s to come in this calendar year.
You do not have to look very far to find the UK’s headline inflation figures: headline inflation has fallen from 11% in autumn 2022 to 4% at time of writing (February 2024). Insignis Cash CEO, Giles Hutson, describes inflation as “a game of two halves”: the UK has won the first half, with headline inflation falling. However, core inflation still sits above 5% and both metrics remain some way above the Bank of England’s (BOE) stated target of 2%.
However, it is important to look beyond the headline inflation number. Headline inflation includes commodities like food and energy: goods that are “imported” and have volatile prices based on factors beyond the UK’s control. The “second half” is to consider the UK’s underlying core inflation, which excludes such prices in its calculations. At time of writing, this figure sits a little higher at 5.10%. The two key drivers of core inflation are firstly, the current UK wage growth at 6.50%, and secondly, unemployment still sits at the historically low level of 4.20% – this is up from a low of 3.70% but still close to historical lows.
So how do these factors impact the UK’s base rate, as set by the BOE, and savings rates offered by the banks?
Insignis Cash has made the following forecast on the UK’s base rate:
However, we also recognise that there are key variables and events which could see rates fall more slowly. These include: the breadth and depth of tax cuts in the Budget statement on 6th March 2024; wage settlements in response to industrial action, principally in the public sector; and global growth figures, most notably employment rates in the USA and the Federal Reserve’s own approach to cutting its base rate.
How this impacts savings rates from the banks is not as correlated as many people may think. It is important to examine the trajectory of the UK’s savings ratio (percentage of disposable income that is saved): this fell from an extraordinary high of 27.4% during the COVID-19 pandemic to 6.6% by Q2 2022, as inflation rose. However, the savings ratio is starting to rise again, based on the most recent data (10.1% in Q3 2023). This would indicate that the burden on households running down their savings is starting to ease. In turn, this creates a more competitive savings rate environment for banks looking to encourage more deposits – as does the emergence of more challenger banks.
A general perception of falling interest rates and instability in the UK economy will also lead many sensible savers to think more carefully about risk.
Increasingly, cash is regarded as an asset class, and should be thought of in the same way that one might regard the stock market – with risk/return consideration, portfolio theory and diversification policy all playing a key role. The collapse of Silicon Valley Bank in 2023 taught us all that the risk to banks is both direct and indirect, and that the most severe implications may not be to consumers, but to SMEs who may currently hold substantial amounts of cash with one bank. (One perspective is that, even though the “temporary high balance” rules can offer some additional short-term safeguards for cash windfalls, it is worth the FSCS considering having different levels of protection – some of which may exceed the current £85,000 limit for different licences.)
Given the current FSCS limits, financial advisers would be wise to help their clients build a multi-tier bank diversification policy. This might be as follows:
By assigning each of their cash deposits to one of these tiers, your clients can help guard against counterparty risk.
Remember that cash is an emotional asset class: clients do not expect to lose money on it, and yet often they may have deposits beyond the FSCS eligibility limit all with one bank – exposing them to risks they may have not considered in full.
Every client that Insignis Cash works with occupies a specific point in a triangle between counterparty risk, liquidity risk and the return profile that those two inputs create.
Breaking a fixed-rate deposit is much harder to do than it was prior to the 2008 financial crash. As such, banks are under greater pressure not to allow withdrawals before a savings product has matured. This means it is ever more important to think about when your clients want their money back. The other factor to consider is the current yield curve: on the Insignis Cash platform, this curve is currently inverted. This means higher rates for products lasting three months to one year, and lower rates beyond one year.
This invites a simple question: why would anyone go beyond one year? The answer is that in an environment where rates are expected to fall in the next twelve months, your clients are effectively invited to consider whether a longer-term product will earn them more interest over 2-3 years. If they don’t actually need that cash on that timeframe, they need to consider the refinancing risk of a short-term product.
There is no blanket right or wrong answer to this debate, but clients would be prudent to consider when they need access to that cash before they consider the potential yield. As Giles Hutson says, “We shouldn’t be interest rate traders.”
Our company is led by banking experts: chairman Paul Richards and CEO Giles Hutson have a combined 50 years’ experience in investment banking. We are proud to help our adviser partners navigate challenging economic waters.
To find out more about working with Insignis Cash, get in touch.