Last week’s rise in interest rates is good news for savers. It means that the return on cash is likely to improve, although many banks had already priced-in a rate rise in recent weeks.
Despite this, savers still face an uphill struggle. Inflation remains significantly higher than the rates which are on offer from even the best savings accounts. And with interest rates unlikely to move to ‘normal’ levels for many years, the reality is that the real return on cash is likely to remain negative for a sustained period of time.
As a result, investing in high-yielding shares such as British American Tobacco (LON:BATS) and Aviva (LON:AV.) could be a sound move.
Interest rate rises
The UK interest rate is currently expected to reach 2% in 2020. Even if it meets estimates, this would mean that cash returns remain negative over the next couple of years. Inflation is expected to be above 2% during the same time period, which could mean further misery for savers in what may prove to be an uncertain period for the wider economy.
Brexit, of course, could have a significant impact on interest rates and on inflation. At the time of writing, a ‘no-deal’ scenario remains a distinct possibility, with the political risk associated with the ‘Chequers Plan’ being relatively high.
Even if a deal is agreed between the EU and the UK, uncertainty is likely to remain high. This could contribute to relatively slow GDP growth, with the UK economy forecast to grow by just 0.5% per annum between now and 2020. As a result, interest rate rises could be slower than expected, given their potential to choke-off what is already anticipated to be a low level of growth.
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While dividend shares such as British American Tobacco and Aviva do not guarantee the return of capital, they do offer a significantly higher return on capital than cash. The two stocks have forward dividend yields of 4.9% and 5.9% respectively for the current year, with dividend growth of 7.2% and 12.8% forecast for 2019 respectively.
Of course, British American Tobacco is experiencing a transitionary period which is leading to uncertainty among investors. Cigarette volumes are falling across the industry, and although price rises are more than offsetting this, it is clearly an unsustainable strategy in the long run. However, with demand for reduced-risk products increasing, the company is well-placed to benefit from a new growth avenue. It expects to double revenue from next generation products this year, with further growth expected in future.
Aviva also seems to have a bright future. It reported solid results today which showed that it is performing in line with expectations. It has been able to redeploy part of its excess capital in areas such as reducing leverage and commencing a share buyback programme. Since the company has a diverse spread of operations including access to a number of fast-growing markets, it seems to be in a strong position to deliver further dividend growth in future years.
Therefore, while interest rates may now be at their highest level since 2009, the reality is that savers may continue to be disappointed by their real returns for many years. Buying dividend shares may be riskier than holding cash when it comes to the return of capital, but the rewards could be worth it.