Q3 2023 Market Update

As financial planners, we are acutely aware that months of turbulent markets have given many investors a rough ride and, over the past 18 months, volatility has been particularly tricky in bonds and gilts. Yet, there are now signs that inflation and interest rates may be reaching their peak, giving investors reason to be optimistic.

In this edition, read expert insight into:

• Welcome news for all as inflation starts to fall
• Watch out for an unexpected tax charge
• What does this mean for investors?

Welcome news for all as inflation starts to fall

During August, inflation fell to 6.7% and, while this figure remains a long way from the BoE’s 2% target, it is a significant improvement on the double-digit figures we have seen over the last year and a substantial reduction on the 11.1% peak seen in October 2022.

With inflation starting to inch its way down, the BoE maintained the base rate at 5.25% in September 2023. Following 14 consecutive rate hikes since November 2021, this was a significant event.

The chart below shows the correlation between inflation and interest rates from January 2021 to September 2023.

Source: Reuters

A long-awaited fall in inflation may indicate interest rates are in or around their peak but only time will tell.

If Huw Pill, chief economist at the Bank of England (BoE), is proved correct, we may be starting to see rates stabilise at or around their current levels. That said, we may not see interest rates start to fall significantly in the immediate short term. Rather, the trajectory of interest rates may resemble Cape Town’s Table Mountain – which boasts a unique flat plateau, stretching almost two miles, before you start to descend the other side.

Should this happen, while interest rates may remain elevated, we could start to see markets beginning to settle.

Watch out for an unexpected tax charge

Though there’s little reason for millions of UK mortgage holders to celebrate just yet, savers have been benefitting from much higher savings rates than we have seen since April 2008. According to data from comparison site Moneyfacts, the highest available interest rate on an easy access savings account is currently 5.30%.

If interest rates are indeed starting to fall, savers may want to consider locking some of their deposit funds into fixed term deposits to secure higher rates of return. Figures from Moneyfacts suggest that committing to a one-year fixed rate bond now could see you benefit from an interest rate payable of 6.12% while two and three-year fixed rate bonds can attract interest rates as high as 6.05% and 5.97% respectively.

However, with savers having not seen such generous rates for some time, it easy to forget the potential income tax payable on interest from savings.

Everyone has a Personal Savings Allowance (PSA), limiting how much interest you can earn before having to pay Income Tax.

In 2023/24, the PSA allows:

Basic-rate taxpayers to earn £1,000 interest during the year before paying Income Tax

Higher-rate taxpayers to earn £500 before paying Income Tax.

Any interest earned that exceeds your PSA will be liable to Income Tax at your marginal rate.

If you are an additional-rate taxpayer, you do not have a PSA. This means that any interest you earn on your cash savings is taxable at 45% in the 2023/24 tax year.

Remember to use your ISA allowance to maximise tax-efficient saving

If you think you might fall foul of having to pay tax on your savings interest, and you aren’t using your allowance to invest, saving through an ISA could help.

Unlike traditional savings accounts, any interest or returns from your ISAs are free from Income Tax and Capital Gains Tax (CGT). Consequently, ISAs can help provide you with a tax-efficient way to save and invest for your future.

In the 2023/24 tax year, you can save up to £20,000 in ISAs. If you are married, or in a civil partnership, together you could save £40,000 each year, and benefit from potentially substantial tax efficiency.

A final word of caution – if you have a lot of cash in the bank, make sure you spread it between different banks and building societies.

In the UK, the Financial Services Compensation Scheme (FSCS) is designed to protect you and your money if your bank or building society fails. The scheme will automatically compensate up to £85,000 for one individual, for each account, and up to £170,000 for joint accounts. Also bear in mind some banking brands share the same banking licence which means your deposit protection is across all brands sharing the licence.

What does this mean for investors?

The volatility investors have seen in bonds and gilts over the last 18 months has largely been due to sustained increases in interest rates. If we are in fact seeing interest rates peak in the short term, and perhaps even start to fall in the medium term, this is potentially good news for investors holding these assets.

Firstly, as interest rates peak, cash is now benefitting from the higher rates of interest payable, while higher yields from fixed interest assets are now providing much higher levels of income than we have seen for some years. Secondly, when interest rates start to fall, the capital value of existing fixed interest investments, such as bonds, should start to increase, leading to capital gains.

While investments will always be affected by short-term fluctuations, if you remain calm and hold a well-diversified portfolio, investing could help protect your wealth from the eroding effects of inflation.

While some headwinds remain, there is lots to be positive about and it is important to remember the wisdom of the celebrated US investor, Shelby Cullom Davis, who said ‘You make most of your money in a bear market. You just don’t realise it at the time.’

We’re here to help

As financial planners, we’ve helped clients weather many economic storms over the years, and that’s something my team and I are proud to continue doing.

Markets may rise and fall, but your investment goals should remain the same, and it’s our job to help you achieve them. For almost 20 years, clients like you have trusted us to provide honest, independent advice in a friendly and professional way.

If you have any queries about anything you’ve read in this update, please don’t hesitate to contact your financial adviser, who’ll be happy to give you all the support you need.

Please note: The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.

All contents are based on our understanding of HMRC legislation, which is subject to change.