Back in March this year, the Bank of England’s Monetary Policy Committee cut interest rates to a record low of 0.10%.

A similar cut to near-zero was made by the US Federal Reserve, while the European Central Bank is already deep into negative territory.

A recent paper published by the Bank of England shows that a decline in nominal interest rates has been a steady trend over the past 700 years, albeit a wild ride along the way.

Figure 1: The decline in nominal interest rates has been a long-term trend

Source: Bank of England

This decline has led some to ask whether we are headed down beyond zero, and whether it will ever be possible to a get a sensible return on low risk assets again? Indeed, the billionaire hedge fund manager Ray Dalio recently proclaimed that ‘cash is trash’, in stark contrast to the old adage that ‘cash is king’.

Last month it was reported that the Bank of England was ‘exploring’ the possibility of negative interest rates, though Governor Andrew Bailey quickly played down such assertions.

But given negative rates are now commonplace on the continent (albeit usually only charged on business deposits and very large individual balances), it does not seem outside of the realms of possibility that we could be heading that way.

National Savings and Investments cut their rates too

Whilst originally holding off on any rate cuts to avoid adding insult to injury for savers hit by the Coronavirus pandemic, state-owned National Savings and Investments (NS&I) has announced that from 24th November it will follow the Bank of England’s lead, and dramatically cut the rates of interest paid by its easy access accounts.

A full list of the changes to the affected accounts is displayed below:

[1] From 24 November 2020, Income bond balances of less than £646 will not earn interest each month.
[2] The rate quoted is the entire prize pool divided by the total amount of premium bonds in circulation. Individual returns will differ depending on luck. The odds of each £1 Premium Bond winning a prize are reducing from 1 in 24,500 to 1 in 34,500.

Please note there are no changes to index-linked savings certificates or existing fixed rate bonds (for instance guaranteed income bonds or guaranteed growth bonds).

As a result of these cuts, a £100,000 deposit in one of its most popular products, the NS&I Income Bond, will see its return cut from £1,160 a year to a meagre £10.

What should you do?

It’s important to note that the current rates on the NS&I instant access products will remain market-leading until the cuts take effect in late November, so there’s no urgency to do anything immediately.

And Premium Bonds will remain an excellent option for cash buffers of up to £50,000 per person, especially as all prizes are tax-free. Mathematically, the more you have saved in Premium Bonds, the better the chances of getting closer to that headline interest rate of 1% per year, and there’s always a tiny, tiny chance of the top prize of a million pounds.

But the other NS&I easy access products will become a poor option for savings, their only advantage being that all deposits are fully underwritten by the UK government.

Go elsewhere and, in the unlikely event of a bank becoming insolvent, only the first £85,000 per person per banking licence is protected by the Financial Services Compensation Scheme (FSCS), and beware that some banking brands (under common ownership) share banking licences, like HSBC and First Direct.

Some easy access accounts elsewhere do currently pay more than the 1% per year, but these are mainly from building societies and challenger banks that probably would not be ‘too big to fail’ – deposits in any such accounts should probably be kept within those FSCS limits.

For larger sums, unfortunately, the rates on almost all easy access accounts provided by ‘too big to fail’ banks and by institutional liquidity funds are now nowhere near close to 1% per year.

It may be possible to get a better rate by tying your cash up in fixed-term bonds – but again most of the best rates (currently only up to 1.60% per year for a 5 year bond) are only offered by building societies and challenger banks. Is the additional return worth being unable to access your cash for years?

It might be time to accept that it is just not possible to generate much of a return on cash any more, and that that is the price to be paid for liquidity and for short-term safety.

Of course, low rates or not, clients should aim to keep a cash buffer of at least 6 months’ expenditure outside of their portfolio.

But if you have surplus cash that you can afford to tie up for sensible investment time horizon (usually 5+ years) then consider whether you should put this to work within your portfolio (taking investment risk) and/or pay down any debt that you may be carrying.

Should you have any questions, please do not hesitate to get in touch.

About The Author

James Payne
James joined the graduate program at Saunderson House in 2015, after graduating from Lancaster University with a first class ...
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