The Bank of England has signaled its intention to raise interest rates, and other central banks, including the US Federal Reserve, are likely to be making a similar response to rising inflationary pressures.
After years of easy money following the financial crisis ten years ago, they are concerned to prevent their economies from over-heating.
What does this mean for investors? The most direct impact will be on fixed-interest securities, or ‘bonds’. These are issued by both companies and governments which wish to raise money from investors. The capital is repaid at a fixed date in the future and meanwhile interest is paid at a rate which is fixed at the time when the bonds are issued.
Government bonds are known as gilt-edged securities, or ‘gilts’, because repayment of the capital invested is guaranteed by the government.
Sone government bonds are index-linked which means that the value of the capital repaid is linked to the Retail Prices Index, thus providing protection against inflation. However, most bonds lack this protection and the value of the capital repaid will be subject to erosion by inflation.
This threat to capital, combined with the low interest rates currently available from bonds, make them a poor investment at times like the present when inflation and interest rates are set to rise.
The best time to invest in bonds is when interest rates are high and set to fall. At such times bonds offer the attraction of higher interest rates than are available from deposits and greater security of capital than is available from shares.