How can charities keep up with a rise in interest rates?

John Hildebrand of Rensburg Sheppards says rates will start to rise shortly

John Hildebrand
John Hildebrand

Mervyn King, the governor of the Bank of England, has now written 13 times to the Chancellor of the Exchequer to explain why inflation has come in above target.

Markets no longer think this is a temporary blip and expect interest rates to be pushed up in the middle of the year in order to keep a lid on inflation.

On the domestic front, a rise in interest rates means higher borrowing costs for mortgages and, therefore, for consumers. This should act as a brake on the UK economy and disposable income: as a consequence, donations could be hit just when demand on charities is increasing.

Rising interest rates in the UK should lead to stronger sterling against the currencies of countries where rates are less likely to rise. But interest rates might rise even faster in some emerging economies, such as India. As for UK charities, those that primarily spend in dollars should benefit - assuming that currencies move in a logical way, which is not always the case.

Holders of low yielding assets, such as gold, or assets with a fixed yield, such as bonds, normally suffer when rates rise because the relative attractiveness of holding these assets falls, compared with cash. However, equities usually perform well before an interest rate rise and even after the first rate rise - as long as rates do not rise significantly thereafter.

The rule of thumb has been that interest rates should be roughly in line with nominal gross domestic product, the rise in GDP when not adjusting for inflation. If this rule were followed today, interest rates would be about 5 per cent. Ten-year government bonds have a lower rate than this but still yield close to 4 per cent. Charities should budget for higher long-term rates.

The other issue for charities is that interest rates are rising because input prices are - so costs for charities are too. Wage inflation is lagging behind retail prices, but there is a risk that wages will move higher as workers see the threat inflation poses to real pay.

The one positive for charities is that many hold cash on deposit and, at last, should start to get a better return on their money. But if interest rates remain below inflation, those that hold nominal assets such as cash will still lose out in real terms.

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