BondsSep 18 2017

Challenger banks drive fixed rate bond yields up

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Challenger banks drive fixed rate bond yields up

The yields available on fixed rate bonds nudged upwards over the past year, driven largely by the so-called challenger banks, according to data from Moneyfacts.

Moneyfacts' data showed the interest rate on a one-year fixed rate bond has moved upwards, from 1 per cent in September 2016, to an average of 1.13 per cent in September 2017.

On a long-term bond, the interest rate has moved to 1.6 per cent September, compared with 1.34 per cent in the same month in 2016.

Charlotte Nelson, finance expert at Moneyfacts, noted fixed rate bonds fell to exceptionally low levels last year in the wake of the Bank of England cutting interest rates, but have nudged upwards since.

Ms Nelson said: ““All of this positivity wouldn’t be possible without the fresh energy of the challenger banks, whose intense competition for the top of the Best Buys has kept rates rising.

"Despite their best efforts, however, rate increases will likely remain small until the larger banks decide to join in."

She added that without the presence of the challenger banks in the market the “picture would be very bleak indeed.”

Ms Nelson said: “Sadly, until initiatives such as the term funding scheme (TFS) are removed from the equation, the main banks are unlikely to change.

"While the term funding scheme is set to end on 28 February 2018, providers who access the scheme have four years to spend the funds, so subdued rates are likely to remain for some time."

The term funding scheme is an initiative by the Bank of England to make cash available to commercial banks at much less than the market rate, in order to encourage lending in the economy.

This matters to the rate achieved on fixed rate bonds because if banks can attain the funding they need from the Bank of England, they have no need to increase the rates they pay to savers to attract their capital.

Ms Nelson said: “Despite the upturn in fixed bond rates, the Bank of England has reported an increase in the flow of money coming out of fixed rate bonds.

"This shows that, at the moment, savers are reluctant to lock their cash away in an account that does not keep pace with the rising inflation rate."

Ms Nelson said: "Despite the upturn in fixed bond rates, the Bank of England has reported an increase in the flow of money coming out of fixed rate bonds. This shows that, at the moment, savers are reluctant to lock their cash away in an account that does not keep pace with the rising inflation rate.”

Last week the Bank of England warned that interest rates are likely to rise at a rate faster than the market is currently pricing in.

Maike Currie, investment director for personal investing at Fidelity, said that even with the likelihood of UK interest rates rising, the pace of increase is likely to be so gradual that investors will continue to need to adjust their portfolios for a world of rising inflation.

david.thorpe@ft.com