It feels as though interest rates have lagged inflation for an eternity. Even though savers have benefitted from tax changes that include the first £1,000 in interest income being tax free, ultimately even the best high street savings accounts lag inflation when it comes to their annual returns.
Although it is difficult to predict where interest rates are headed with Brexit on the near-term horizon, dividend shares could provide a simple solution to a lack of return in real-terms from cash. While headline yields may be appealing at first glance, though, shares offering high dividend growth potential could be even more attractive in the long run.
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Interest rates are forecast to reach 2% in 2020. The reality, though, is that Brexit makes it exceptionally difficult to predict whether they will rise or fall over the next few years.
Even Mark Carney, the governor of the Bank of England, seems unsure as to which way interest rates will move post-Brexit. He had previously suggested that they may need to fall if a no-deal Brexit occurs, since the economy could require further stimulus in order to support it during an uncertain period. Recently, though, he has indicated that inflation may spike in a no-deal scenario, and this may require a higher interest rate in order to cool the rate of price increases.
If a Brexit deal is agreed, interest rates could move higher over the medium term as per current expectations. However, the pace of their rise is expected to be relatively modest.
Due to the uncertainty facing interest rates and inflation, dividend shares could continue to increase in appeal. With the FTSE 100 having experienced a ‘correction’ in recent months, the index now yields over 4% and a number of its constituents have significantly higher yields. In fact, it is possible to generate a high-single digit yield from a handful of index incumbents.
Dividend growth stocks, though, could offer stronger income investing opportunities in the long run. Furthermore, fast-rising dividends may beat inflation in an era where the UK could experience a period of instability following Brexit.
Two shares which offer the potential for high dividend growth are AstraZeneca (LON:AZN) and Unilever (LON:ULVR). They yield 3.4% and 3%, respectively, with AstraZeneca expected to deliver earnings growth in the next financial year after a challenging period.
The company has invested heavily in its pipeline as generic competition has led to declining profitability in recent years following the loss of patents on several key blockbuster drugs. With earnings due to rise 13% next year and its dividend being covered 1.2x by profit this year, its capacity to raise shareholder payments may increase.
Unilever may also be able to increase dividends at a fast pace. Since most of its revenue is generated in emerging markets, it has a strong foothold in countries where wage growth is forecast to remain high over future years. Although there are potential risks ahead from a rise in US interest rates and its possible impact on emerging markets, the company’s diverse geographic exposure could help to limit its overall risk. Since dividends are covered 1.5x by profit, shareholder payments could rise at an above-inflation rate over the long run.