Interest rate cuts – what it means for markets and investors

Last week we saw the US Federal Reserve (Fed) cut interest rates for the first time since 2020, while the Bank of England (BoE) voted to keep the UK base rate on hold at 5%.

The Fed cut from 5.25% to 4.75% – a decision that was widely anticipated due to the tightening job market and weakening of the US economy. With inflation starting to cool, as well as a desire to stimulate the economy and avoid a recession, further reductions are expected across the pond in the coming months.

In the UK, the decision to hold the base rate at 5%, follows a cut in August from 5.25% – where it had been since August 2023. While further rate reductions are expected here in the UK, the BoE is likely to continue a tentative approach given inflation remains above the Bank’s 2% target. New data released last Wednesday revealed that inflation rose to 2.2% in August .

The BoE is more likely to keep rates high when it believes inflation is rising too quickly – among other factors.

Before August’s reduction, the last time rates were cut was in March 2020, when the base rate was reduced to an ultra-low level of 0.1%.

Eventually rates rose, gradually and then more sharply in the aftermath of the pandemic as inflation soared.

Rates could fall further, eventually to what might be perceived as a more normal level – somewhere in between the highs of now and the ultra-low rates of 2020. The next decision on rates will be made on 17 October.

Predicting what might happen to interest rates in any economy is extremely difficult, so investors need to proceed with caution if they’re trying to base investment decisions on what changes they think might be made.

A change in interest rates does, however, impact the world of investments, as well as the economy. Here are some of the key things you need to know:

What the rate cut means for markets and investments

Markets are forward looking which means some rate cuts have already been priced in.

We need to be wary of leaning too hard on any rules and norms with regards to interest rates and their effect on either the economy or capital markets. The last few years have contained plenty to upend textbooks and experts alike.

Even so, we can expect a move away from keeping rates high to help the wider economy. Economic growth is obviously the driving force for profits growth, so these can be a good moment to own stocks.

Falling interest rates impacts bond markets in a different way. All things being equal, when interest rates fall, the fixed rate of income (also known as a coupon) on offer becomes more appealing. This means that bond prices are driven higher – so they become more valuable – and more expensive to buy. However, as noted above, the BoE’s decision to hold interest rates this month, was expected. Any moves within fixed income will reflect grappling with the potential for further interest rate cuts.

Impact of a rate cut for investors

Rate cuts can encourage individuals to get their money invested. Conversely, high interest rates can result in a reluctance among individuals to invest – some people feel there’s limited value in investing when they can get a decent return by keeping their money in a savings account.

But it’s important to remember that cash savings rates available are not long-term expectations. Interest rates can change and when they start falling, like now, so will the interest on your money held in variable rate savings accounts. Savers with money in fixed rate accounts will have some protection from falling interest rates, but when those fixed terms end, the rates on new deals will be lower.

So when interest rates are cut it often serves as a reminder to savers that they could get their money working harder by looking at investments.

Investing offers the chance to beat returns from cash – and historically it does, over the long term. But remember, past performance is never a guide to future performance and you might get back less than you invested.

Figures show that depositing £10,000 in our Barclays Everyday Saver Account compared to investing in UK shares would result in a smaller return, over the five-year period from January 2019 to end of December 2023.

It’s also worth remembering that there is tax to pay on any savings interest income over £1,000 if you’re a higher rate taxpayer, and £500 if you pay additional rate tax.

Whereas any investments held in an ISA are free of tax on any capital gains or income.

Will Hobbs, Head of Multi-Asset Wealth at Barclays Private Bank and Wealth Management, explained: “Cuts in interest rates form part of a wider move to normalise interest rates across the developed world. Inflation increasingly looks a beaten foe, to that extent it is time to take these economies out of the monetary policy emergency room.

“We expect more rate cuts to come from the Bank of England, taking us towards what is considered a more normal level.

Yet no matter what rates are doing, getting invested and staying invested remains the core mantra for long-term investors.”

Getting invested

If you decide you want to start investing, or to boost your existing investment coffers, then remember key investment strategies that could help you:

Be diversified

Investing across different sectors, asset classes and geographical areas can protect your savings. This approach means that if one or more of your investments rise, you will benefit, but, if they fall, there should be some protection because, hopefully, some of your other holdings in different asset classes, regions or sectors will be going up in value.

Invest regularly

Regular investing is a popular strategy that means you don’t need to worry about the best time to invest, according to what markets are doing. By drip feeding your money into an investment over time, you invest across a range of prices. This effectively means you pay an average price over a fixed period, which can help smooth out market volatility.

Your buying power increases when the share price falls as you can buy more shares at cheaper prices. That same buying power drops when prices rise when you buy shares and funds when they are expensive and buy fewer shares. This is known as ‘pound cost averaging’.

Benefit from compound growth

Investing over the long-term allows you to benefit from the power of compound growth . In simple terms, your money earns a return in the first year. As long as it is reinvested, in the second year both the original investment and the return benefit from any growth in the second year. In the third year your investment is further enhanced by any reinvested returns achieved. This snowball effect is called compound growth.

Maximise tax perks

Maximising ISA and pension allowances mean you pay less tax and so your money can grow faster.

Each April investors are given a fresh ISA allowance which allows you to shelter up to £20,000 from tax.

You can also contribute up to £60,000 a year into a pension (or up to 100% of your annual salary, whichever is lower).

Not everyone has a lump sum they want to invest, so a regular amount makes sure you utilise as much of the tax breaks as you can afford.

Using existing tax breaks on investments is particularly important due to speculation that the upcoming Budget on 30th October could result in higher tax bills for some.