A fall in inflation figures to below target for the first time in three years could spell good news for mortgage rates, equities and bonds, said AJ Bell.
On 16 October, the Office for National Statistics announced that inflation fell to 1.7% in September, below the Bank of England’s 2% target. The drop in figures has sparked speculation that the Bank of England will cut interest rates, with a 25 bps cut widely expected to be announced next month.
Lower interest rates are expected to feed through to lower mortgage rates, which will be good news for anyone stepping onto the housing ladder for the first time as well as for those remortgaging, said AJ Bell.
However, how borrowers feel about coming off their old deal will “very much depend on when it was brokered,” according to Laith Khalaf, head of investment analysis at AJ Bell.
Five year fixes coming up for renewal would have been taken out in the fourth quarter of 2019, when a typical rate for a 75% loan to value stood at around 1.7%, meaning those borrowers may be in for a “nasty rate shock”, according to Khalaf. In contrast, those on two-year deals who have had to pay significantly more in the wake of former Prime Minister Liz Truss’ mini-Budget will benefit from lower rates.
Lower inflation is also good for conventional bonds, increasing the value of their fixed income streams as well as serving to lower expectations for interest rates, pushing down yields and inflating prices, said AJ Bell.
If inflation continues to come in below expectations, it would prompt markets to accelerate and deepen their forecasts for interest rate cuts which would be positive for bond prices.
Khalaf said: “Gilts are currently yielding 4% at the two year maturity, which doesn’t look too sharp for savers when you consider the best two year fixed term accounts are yielding somewhere in the region of 4.5%. However, the gilt yield starts to look more attractive for low coupon government bonds which offer a return which is almost tax-free, because gilts aren’t subject to capital gains tax.”
Equities are also set to benefit from lower inflation, with dividends and capital growth looking more attractive in real terms.
Khalaf said: “A more buoyant consumer less constrained by inflation also spells good news for companies which sell discretionary items to UK households. The prospect of lower rates also reduces discount rates on future profits, boosting their present values. Lower bond yields would also mean companies could take on debt at a lower cost, leaving more revenue to flow through to the bottom line.
“Overall, a period of falling interest rates and contained inflation provides some positive mood music for equities, though limp economic growth and a lack of investor confidence may continue to drag on performance of the UK stock market.”
While on the face of it lower inflation should signal good news for cash savers, lower interest rates will feed their way into lower cash rates too, says AJ Bell.
“Cash savers still have their head well above water when it comes to beating inflation, with the best rates still offering around 5%. With CPI coming in at 1.7%, it’s tempting to think this translates into a real return of 3.2%, but actually the latest inflation reading measures inflation over the last year, and it is future inflation which will impact on the real return enjoyed by savers,” he added.
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