The impact of interest rate changes

Interest rates are expected to rise gradually over the next few years, although it is impossible to say exactly when and by how much. In this episode, Clare is joined by William Hobbs, Barclays’ Head of Investment Strategy, to discuss what impact interest rate changes can have.

The value of investments can fall as well as rise and you could get back less than you invest. If you’re not sure about investing, seek independent advice.

Clare: Hello I'm Clare and welcome back to Smart Investor, the series that helps you get to grips with investing. Interest rates are expected to rise gradually over the next few years although it's impossible to say exactly when and by how much because of all the factors that can influence interest rate movements. However, if you have investments or are thinking of investing for the first time it's worth understanding what impact interest changes can have. To discuss this in more detail I'm joined by Will Hobbs who's Head of Investment Strategy for the U.K. and Europe at Barclays. Please be aware though we can't offer personal advice so if you don't feel confident about making an investment decision on your own do seek independent financial advice. Will thanks for joining me today. So can you just explain why interest rates change?

Will: Yeah, Clare as you just alluded to it's a complicated question, I mean one way to think about it is to imagine the economy as a car that has an optimal speed at which it can travel; if it starts accelerating above that speed it starts to do a bit of damage to the car, the same as for the economy. There is a perfect speed at which it can travel. If it starts going above that level you start getting more inflation and that starts to do more damage to the economy; so in a sense what happens in those situations is the Central Bank and us are part of sort of the driving force of the economy and interest rates tend to rise when the economy is accelerating, and central bankers are there to try and keep those interest rates, or use those interest rates to manage the economy's speed so that it's not travelling above that speed and doing damage to the economy over time.

Clare: So it always like a bit of a brake or an accelerator?

Will: Yeah that's one way to think about it.

Clare: So why does this matter so for consumers for you and I, why does it matter?

Will: From a consumer perspective it obviously, it's the cost of accessing money; because there's two sides of it. On the one side I look as a consumer, when I looked at borrowing money, I'm obviously getting advantage from not having to save up for it, I'm gonna get it immediately and there's a cost to that that's an interest rate, and on the other side of it the lender is looking at the risk of lending to me and so they demand some form of compensation for making that transaction, for lending me the money and that is the interest rate and as the interest rate rises that obviously deters me a little bit more from borrowing. It costs me more money to access the money that I wanna access now and that should in the end mean that I borrow less, the economy tends to slow a little bit. So that's how it affect consumers generally.

Clare: And obviously at the moment where in an environment where we're expecting to see interest rates go up over the next few years, so from our investor perspective what impact will that have on investments?

Will: It has a number of impacts and again it's a very complicated question because we've been in a period really unprecedented where interest rates have just been on the floor all over the world for a long period of time since the great financial crisis pretty much and we're now as you say entering a period where interest rates around the world and almost every country are set to rise gradually. Now the market is expecting some of this and to that extent it shouldn't really affect investments when central bankers do as expected. However, it is when central bankers raise interest rates a little bit faster than can be expected, then you start to see a bit more of an impact on investments generally. In terms of sort of making a decision on investments there is a quite an interesting thing to think about on the one hand you have the decision to kind of lend to a company or a government, which is relatively defensive decision, that's a bond more or less, and really what I'm looking for is my money back plus an interest rate. On the other side I have a sort of more positive decision in a sense which is I wanna own a stake in global growth a proportionate stake in global growth and that's owning in equity; now as interest rates rise, if I'm looking as a new investor at it, then it get a little more attractive potentially as the interest rates on the bonds rise because it's a more potentially attractive investment. And on the other side of it because it's having a slightly slowing effect on global growth the benefit of owning a stock is slightly less and so it does change the debate between owning stocks and bonds just a little bit as interest rates rise.

Clare: And I guess that's why it's really important to build an investment portfolio that has exposure exposed and has a mixture in diversification.

Will: Absolutely and I think you always wanna own both because the reality is that while, you know as I said as allocators we're always trying to guess at what the future holds, and what inflation growth and interest rates are in the pipeline, for investors and how you should build your portfolio around that. The future's unknowable; profoundly and reassuringly so. And so we're always trying to provide for a future that we don't know everything about and to that extent you're always gonna own stock time bonds in a portfolio.

Clare: With that in mind, obviously, nobody knows, but what's the sort of current view, are you expecting any interest rises this year?

Will: We're in a situation in the UK economy where, when we talked about the sort of speed limit earlier that speed limit, the central bankers don't exactly what that is, they're always guessing at the speed limit for the economy; the interesting thing you're finding in the UK economy at the moment is that most of the time interest rates are rising because the car is accelerating essentially, but what seems to be happening more at the moment is that the speed limit is coming down. So because of Brexit, the productivity conundrum people are talking about, that means the pace at which the economy can grow without doing damage to itself is a little bit less. So the central bankers are keen to raise interest rates but in a sense the growth data and the inflation data isn't really giving them the opportunities and I think the best thing we can say about the U.K. economy at the moment is we're expecting a kind of long and drawn-out rate rising cycle, with one maybe two rate rises for the next couple of years.

Clare: Thanks very much Will. That's some great insight there. We have lots more information about investments and how interest rates changes can affect them on our website which should help improve your knowledge and understanding. Thanks for watching and see you again next time.

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