Higher for Longer: What Sticky Interest Rates Mean for Gold

5 min read

For years one rule was repeated in every market commentary. When interest rates are high, gold falls. In April that rule was tested again. Interest rate cuts were pushed further into the future on both sides of the Atlantic. Gold rose to fresh records anyway. For savers trying to understand money, this is one of the most important things happening today.

A month of new highs

Last month we wrote about gold breaking records while savers wait. April went further. On 12 April gold reached a new all-time high. In pounds it set a record too.

The price eased in the second half of the month as some buyers took profits. It still ended April up around 2.5% on the month and around 11% since the start of the year. A pullback after a run like that is normal. What matters is how much of the gain it has kept.

Higher for longer

At the start of the year markets expected several rate cuts in 2024. Those hopes have faded. US inflation came in at 3.5% for March, higher than expected. On 16 April the Chair of the US Federal Reserve, Jerome Powell, said recent data had not given the Fed greater confidence on inflation. Gaining that confidence, he said, was likely to take longer than expected. Markets heard the message. Cuts are now expected later and in smaller numbers.

The detail of the American figures explains the worry. The Bureau of Labor Statistics reported that prices rose 0.4% in March alone. Core inflation, which leaves out food and energy, was 3.8% over the year. Housing costs rose 5.7% over the year. Housing and petrol together made up over half of the monthly increase. These are everyday costs that households cannot easily avoid.

Ten-year US government bond yields climbed back above 4.6%. The US dollar strengthened. On the old rule, gold should have struggled.

The picture in Britain is similar. UK inflation fell to 3.2% in March, but Bank Rate remains at 5.25%, where it has been since last August. The Bank of England has said it needs more evidence before it moves.

Why the old rule is breaking down

The old rule was simple. Gold pays no interest. When cash and bonds pay a good return, many holders sell gold and buy them instead. For much of the last 20 years that relationship held well.

It has not held since 2022. Rates rose at the fastest pace in a generation, yet gold has climbed to record after record. There are three reasons.

The buyers have changed. The traders who move in and out of gold on interest rates are no longer the main buyers. Central banks are. They do not sell gold because a bond yield ticks up. They buy it for safety and they hold it.

The difference is one of time. A trader may hold gold for a few weeks and sell when a bond pays more. A central bank may hold the same gold for decades. When the long-term buyers make up more of the market, short-term moves in interest rates matter less to the price. That is the shift the old rule never allowed for.

Debt has changed the maths. Governments now owe so much that high interest rates are expensive for them too. Every rise in rates adds to the cost of servicing the debt. Markets understand that rates cannot stay high for ever without strain somewhere in the system.

The American figures make the point. In February the Congressional Budget Office projected that the US would spend $870 billion on net interest in 2024. That is more than the $822 billion it expects to spend on defence and more than the $851 billion it expects to spend on Medicare. By 2034 the annual interest bill is projected to reach $1.6 trillion. Over the full decade interest would total $12.4 trillion.

A government paying that much in interest has every reason to want rates lower. That is why high rates may prove harder to sustain than they look, whatever central banks say in the short term.

Trust has changed. In 2022 Russia's dollar and euro reserves were frozen. Central banks everywhere took note. A bond is only as safe as the government that issued it. Gold held in your own vault is no one else's liability.

The central banks have not stopped

New figures from the World Gold Council show that central banks bought 290 tonnes of gold in the first three months of 2024. That is the strongest start to any year on record. Turkey, China and India were among the largest buyers. China's central bank has now added to its gold for 17 months in a row.

The council's wider report, published on 30 April, shows the scale of demand. Total gold demand in the first quarter, including large private deals made directly between buyers and sellers, was 1,238 tonnes. That was the strongest first quarter since 2016. Demand for bars and coins rose 3% on a year earlier to 312 tonnes. Jewellery demand slipped only 2%, despite the higher price.

It happened even though Western funds were selling. Gold exchange traded funds around the world lost 114 tonnes over the quarter, with inflows in Asia not enough to offset outflows in North America and Europe. The average price for the quarter was still a record $2,070 an ounce, 10% higher than a year earlier. Within Asia, China accounted for the bulk of the new money going into gold funds. When the price rises while some of the best known buyers are selling, it tells you someone else is doing the buying.

These are the institutions that set interest rates and issue currency. They are watching the same numbers as everyone else. They are still choosing gold.

What it means for savers

High rates have been good news for cash savers on paper. But a rate of 4% or 5% is only half the story. Inflation takes its share first. Tax on savings interest can take another share. What is left is often a small real return, or none at all.

A simple example shows how. Take £10,000 in an account paying 5%. That earns £500 in a year. If tax takes a fifth of the interest, £400 is left. With UK prices rising at 3.2%, goods that cost £10,000 a year ago now cost about £10,320. The real gain on the year is about £80, less than 1%. For a saver paying a higher rate of tax, the real gain can disappear altogether. The headline rate looks generous. The real return is far thinner.

Gold works on a different principle. It does not depend on a central bank's decision or a government's goodwill. It simply holds its value against currencies that are created in ever larger amounts. When rates eventually fall, that difference becomes clearer still.

UK legal tender gold coins such as the Britannia and the Sovereign also carry a tax advantage. Gains on them are exempt from Capital Gains Tax for UK residents.

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Sources

This article is for information only. The value of gold can go down as well as up.

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Gold Insights are independent articles, researched and written by our own team at Gold Tier Advisory.