Interest rates in the UK have already started to rise. The Bank of England is now expected to increase them further over the coming months, with the UK now seemingly on a road to interest rate ‘normalisation’ over the medium term.
However, the chances of a rapid rise in interest rates seem slim. Inflation has cooled in recent months, while policymakers are unlikely to risk hurting the UK’s economic performance as Brexit becomes a reality.
Therefore, dividend stocks are likely to remain a useful tool for income investors – even though assets such as cash and bonds may become more attractive over the next few years due to higher interest rates.
Interest rate rises
In recent years, the appeal of assets such as cash and bonds has been limited to a large extent by their relatively low yields. Although inflation has itself been low over a prolonged period, the real returns on fixed income and cash assets have generally been significantly less appealing than those of a wide range of dividend shares.
This situation looks set to continue over the next few years in spite of prospects for a higher interest rate further down the line. While Brexit talks have continued to progress better than many investors (myself included) had anticipated, there is still a long way to go on a number of different issues. The Irish border question is an obvious example. And while there has been progress in a number of areas, nothing is agreed until everything is agreed.
Similarly, the rate of inflation has adopted a downward trend in recent months. The strengthening of the pound has been a factor, with lower CPI putting the Bank of England under less pressure to raise interest rates. Should this trend continue, interest rate rises could be more limited than currently anticipated by the wider market.
Income potential
Against this backdrop, income shares such as Imperial Brands (LON:IMB) and Berkeley Group (LON:BKG)could remain relatively appealing over the medium term. Imperial Brands has a dividend yield of 6.7%, with dividends per share forecast to rise by 9.3% per annum during the next two years. This means that due in part to a depressed share price, the stock could have a yield of 8% in 2019.
Since the business continues to have pricing power in tobacco categories as well as scope to grow its sales in next generation products, it seems to be in a strong position. Due to its defensive characteristics, it may also provide a degree of certainty in volatile market conditions.
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Berkeley’s dividend yield could amount to 5% per annum over the next three years. However, this depends on the proportion of capital returned to investors which is utilised in a share buyback programme. The company is experiencing uncertain market conditions, but the capital which is set to be returned is expected to be generously covered by earnings over the next few years.
Therefore, while neither stock is popular at the moment, the dividend prospects they offer could make them relatively sound investments for the long run. With interest rates unlikely to rise rapidly, dividend shares may prove to be the best fit for income investors over the next few years.