Recent history suggests this might be a case for preferring equities. Since 1989 there has been a statistically significant negative link between Bank rate and subsequent annual equity returns, if we control for the dividend yield and inflation. In this sense, a low Bank rate predicts rising share prices. This relationship points to the All-Share index rising 8.7 per cent in the next 12 months, if the Bank's inflation forecast is right, with a one-in-four chance of it falling.
Sadly, however, the case for shifting into equities isn't as strong as this suggests.
For one thing, this relationship points to good returns only because inflation won't rise very far; 1.3 per cent inflation would still be well below the long-run average. In fact, rising inflation is bad for shares: since 1989 each percentage point higher inflation has been associated with two percentage points lower returns on equities. controlling for Bank rate and the dividend yield. This tells us that if you expect inflation to rise a lot, you should not hold equities. (Personally, I'm not sure it will rise much, but that's beside the point).
But there's something else. The negative relationship between Bank rate and subsequent equity returns is a relatively recent one. From 1989 to 2007 there was no significant correlation between the two, although there was between returns and inflation. This poses the question: how much weight should we place on the fact that the post-2008 evidence that a low Bank rate has led to rising share prices?
Not much, I suspect. On two occasions since then share prices have risen sharply because investors were relieved that we avoided catastrophe. In 2009, the absence of a massive depression caused prices to jump. And in 2012, prices rose again because the feared euro crisis dissipated. These two episodes give the impression that low Bank rate has sometimes led to massive rises in prices. But of course, correlation is not causality.
For me, all this suggests it would be dangerous to switch a lot from bank deposits to equities. How you split your wealth between cash and equities should depend far more upon your appetite for risk than upon the level of interest rates. Of course, sustained low rates are exasperating - if it weren't for them I'd be retired by now. But frustration with them should not lead us to abandon cash entirely. After all, the worst that can plausibly happen to cash is much better than the worst that can plausibly happen to shares.
The numbers
A simple regression of annual changes in the All-Share index upon CPI inflation, the dividend yield and Bank rate (both lagged 12 months) since January 1989 gives us:
All-share = -28.3 + (12.4 x yield) – (0.62 x Bank rate) – (2.0 x CPI)
The R-squared on this is 25.6 per cent, and the standard error is 12.6 percentage points.
The coefficients are intuitive. Each percentage point above-average dividend yield is associated with equity returns being 12.4 percentage points above average, whereas a percentage point above-average Bank rate is associated with returns being 0.62 percentage points above average. This tells us that the dividend yield matters far more for returns than Bank rate.
