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4 August 2016, 17:54

First thoughts on impact of interest rates cut on charities

For the first time since 2009 the Bank of England has moved interest rates, not up but down, to 0.25%. What does this mean for charities? Here are my first thoughts on this important economic decision.

UPDATE (05/08/2016): Household incomes set for further squeeze

Just managed to get a look at the Bank of England's projections - which they use to set interest rates and for decisions on further quantitative easing. The worrying bit for charities, I believe, is contained here. Real post-tax household income is still to grow much more slowly over the next two years (0.5% in 2017 and 1.25% in 2018) when compared to 2016 and indeed to the long term trend. This is something that I have blogged about consistently because (and this is only a theory) disposable income growth is a good marker for fundraising income for the sector. As we have become more dependent on giving and spending by individuals, due to cuts from government, this data is quite worrying. Moreover, for charity employers, the cause is also worrying. As you can see from the table, earnings actually do OK (not great after 7 years of relatively sluggish improvements, but alright). However, it is inflation which is doing the damage to post-tax household income. Falls in sterling are going to lead to higher levels of inflation (as we import much more than we export) and this is going to erode the value of the pound in your pocket. So charities will need to prepare for potentially significant increases in costs, at the same time that households are coming under renewed pressure. Charities need to start planning ahead.

Prepare for choppy waters, but what will the government do?

This interest rate cut (and £170bn quantitative easing programme announced alongside it) were a certainty after yesterday’s economic data. The Markit all-sector PMI shrunk significantly – the biggest one month fall in 20 years – on the back of a spending slowdown and indicated that the UK was heading for a contraction of 0.4% in the third quarter of this year.* After all the guessing about whether the UK decision to leave the European Union would lead to an impact on the ‘real’ economy – the answer appears clear. Yes. Charities tend not to be immediately hit by economic contractions, as demonstrated by the last recession, and if this is a temporary blip (which most economists predict) then the impact on charities should be limited. However, if this turns into a longer slow down, then charities could be significantly impacted. The review into the financial sustainability of the voluntary sector found that charities had taken longer to recover than the mainstream economy from the shock of 2009.  The only bright spot was the fact that individuals kept giving, but can this be sustained following another slow down? The real short term impact for charities will be whether the government decides to change its fiscal plans. Already the budget surplus target for 2020 has been dropped, but will the new Chancellor open the spending sluice gates in the Autumn Statement? At a recent DSC Brexit Seminar, I argued that a recession (mild) although bad for beneficiaries and businesses may not be necessarily bad for charities if it led to the government pump money into the economy by spending more money on services and projects in communities. The sector has seen big cuts in government spending over recent years, and this could see this trend (briefly) reversed; giving charities more time to adapt their business models. Think back to New Labour programmes such as the Future Jobs Fund, deferral of business rate payments, strategic investment funds etc. However, it is unlikely that this government will take such a path. The Bank of England’s £170bn stimulus programme is an implicit recognition from Governor Carney that this government is not keen on spending more money to support the economy. But if this downturn looks more serious, the new Chancellor may be forced to get his cheque book out for the Autumn Statement. This would change the complexion of the Autumn Statement and may support efforts by charities to call for policy changes that could support employment and jobs – such increasing business rates to 100% and reforming irrecoverable VAT to enable the sector to spend over £1bn on charitable services.

Investment returns for charities

Charities are usually long term investors, so short term changes to the economy shouldn’t necessarily have a big impact. However, this interest rate decision has put ‘safe haven’ assets such as UK government bonds (gilts) under further pressure. They have fallen to record lows today and could fall further if the Bank of England is forced to do further stimulus. For charities that may have decided to protect their endowments from volatility in the stock market by buying gilts, this is likely to be bad news. But the decision to restart bond buying by the Bank of England could benefit those charities that have put more of their investments in ‘risker’ asset classes such as equities. Welcome news in the light of the FTSE’s fall post-referendum. Most charities will have a balanced portfolio to spread the risk, but for those that have stuck with equities despite the volatility, this could be helpful. For charities that have invested in properties, this rate fall may be welcome news (depending on their mortgage). But for charities that are sitting on large cash deposits as liquid reserves, this fall in interest rates could signal a start by banks to start charging for bank deposits – Natwest started charging ‘business account’ customers last week. This means that it may be time for charities to think again about how they hold their reserves and reconsidering investment, rather than sitting on cash.

DB Pension Scheme Armageddon? 

My colleague, Anjelica Finnegan, that watches the pensions space made a really good point. Could this see DB Pension scheme Armageddon? DB schemes are already struggling with low interest rates which are making it harder to generate safe returns to fund pension promises. This cut (and the signal of low interests for a good while to come) could tip some pension schemes over the edge and with it, see organisations forced to close. We've already seen a number of charities brought down by pension schemes in deficit, and charities that are in DB schemes should contact their advisers as soon as possible to find out what the decision means for them and their liabilities. The added problem facing the sector is that pension scheme liabilities are now reported in their accounts, so there is no where for charities to hide!

Foreign exchange – what to do?

Charities that work overseas have not had an easy time lately, with the pound taking a battering after Brexit and the decision to cut interest rates has led to further falls (around 1.4% against the dollar and Euro). If this recession turns into something more long-term, the Bank of England may need to carry out further quantitative easing which would further weaken sterling. This means that charities will need to review their budgets for the coming year – perhaps building in further contingencies should there be further changes in interest rates (with the Bank of England preparing the markets for a further fall to 0.1% later on in the year). CFG will keep monitoring the impact of the economy on our sector through our regular Economic Outlook Briefings – which you can download from our website for free.

*Yes, in the wash a lot may change and we may even find that we never even entered a recession at all - but the point to remember is that the 'animal spirits' (as Keynes put it) have been sucked out of the economy in the short term and this will have an impact on the real economy. The difference between a mild recession and slow growth, for these purposes, is minimal.