No film references this time but for those of you with a musical bent, “Here we go again”, as sung by the Isley Brothers, Whitesnake, and The Weekend (ask your kids, or grandkids even!), would sum things up nicely.
At its latest meeting, the UK Monetary Policy Committee (MPC) kept interest rates unchanged, for the first time since November 2021. Growth indicators have been declining and the labour market, whilst still strong, is showing signs of loosening; unemployment has risen slightly and vacancies have reduced. This suggests that the impact of higher interest rates is starting to be felt in the economy and the MPC deemed it necessary to adopt a wait and see approach. At the same time headline and core inflation fell slightly in August, although rates remain elevated. Confusing the picture, retail sales in August rose confounding expectations of reduced consumer spending. The general view at this point seems to be that the UK will either experience a mild, short-lived recession in the next 6-12 months or that economic growth will remain anaemic at best.
In the US, the Federal Reserve kept rates on hold again and Chairman Jerome Powell spoke of his confidence that a ‘soft landing’ was possible. A soft landing is economic jargon for the central bank doing just enough to impact economic activity in order to reduce inflation without pushing the economy into recession. Inflation is now down to 3.7% in the US, unemployment remains low, job gains have slowed but remain positive and economic activity is relatively strong. Europe remains stuck somewhere between the UK and the US, with lower inflation and interest rates than the UK but worse economic growth than the US.
China continues to struggle following its reopening from Covid lockdowns. Lower global demand seems to be impacting negatively on exports, economic growth is weaker than expected and the consumer is spending less, possibly through conserving cash in case of further lockdowns in the Autumn/Winter. The Chinese government is trying to promote growth by tweaking policies, but larger stimulus may be necessary.
Markets
Since the last update early in July, markets are generally higher with the UK’s FTSE All Share performing particularly well, up 6.5%. Whilst remaining volatile, this positive performance reflects a better outlook for inflation around the world and what may prove to be a peak in interest rates. This has also resulted in better returns for bonds in recent months.
Whilst it may not seem like it, returns in 2023 so far have actually been quite positive with global markets up more than 10%. However, a significant amount of this rise is due to a very small number of large US companies involved in AI, who have seen their share prices rise significantly this year. This optimism is not reflected quite as much in the broader stock market which arguably is more reflective of the global economy.
Cash vs inflation vs shares
Returning to a theme of recent updates, and a question I am being asked a lot recently; should I put my money in cash or shares? This is a perfectly valid question in the current conditions where you can get a 1-year, fixed rate bond paying 6.2% but investments are volatile and generally treading water.
The first thing we need to consider is the relationship between inflation and interest rates. When inflation rises too high central banks raise interest rates in an effort to bring it down. Higher interest rates make it more expensive for households and firms to borrow money, decreasing spending and encouraging them to save. Slower spending and investment will result in prices rising more slowly, slowing the rate of inflation and growth in the economy. The same principle holds in reverse: when inflation falls or economic growth is stalled, lowering interest rates makes borrowing cheaper, and reduces the incentive to save. This encourages households and firms to spend, increasing economic growth and the rate of inflation. So, cash rates may be high now but once inflation falls central banks will be keen to cut interest rates to boost economic growth. We can see this in markets: the best cash rates on offer are those for 1–2-year bonds suggesting banks believe rates will be lower further out and, following the Bank of England’s last decision to hold rates in September, mortgage rates have started to decline.
Secondly, we need to consider the objective for the money. For emergency funds, short-term (less than 5 years) capital spending and other secure capital, then cash is fine; it provides access, security and currently, a reasonable return. How much we each need for these purposes depends on our stage of life, assets, spending patterns and personal views on risk. For money which can be put away for the longer-term we need to try to get a return in excess of inflation, otherwise our money will just lose its purchasing power. Cash is unlikely to provide this over longer periods of time, whereas shares (see last update) offer the potential for returns above inflation, albeit they may (and do) go through periods of flat or negative returns.
The table below show the average annual return, after inflation (known as the real return), from UK equities, UK gilts, UK corporate bonds and cash over the last 10, 20 and 50 years. As you can see, over the last 10 and 20 years, cash has provided a negative real return (it would have lost you money after inflation) whereas shares and bonds would have provided a positive real return. Over 50 years, cash would have provided a small positive return of 1%pa on average but shares would have provided a real return of 5.3%pa.
Barclays Gilt Equity Study 2021: UK annualised real returns by asset class
| 10 years | 20 years | 50 years | |
| Equities (shares) | 2.9 | 1.7 | 5.3 |
| Gilts | 3.8 | 3.1 | 3.6 |
| Corporate Bonds | 4.3 | 3.2 | |
| Cash | -2.2 | -0.5 | 1.0 |
So, in summary, take advantage of the current high cash rates for money which is held on deposit for short-term or security reasons but keep in mind the longer-term objectives for investments, even when investment conditions may look less rosy in the short-term. After all, markets often provide the biggest returns when we least expect it…… but I’ll keep that subject for another update.
The views expressed are those of the author and are not intended as personal advice. Past performance is not a guide to future returns. The values of any investment can fall as well as rise.