Last week the Governing Council of the ECB, led by Mario Draghi, decided to cut interest rates by 25 basis points to 0.25 per cent. At the press conference announcing this cut, Draghi referred to “diminishing price pressures in the euro area” and “broad-based weakness of the economy and subdued monetary dynamics”.

Essentially, while the euro area is showing some signs of growth driven by a combination of domestic demand and growth in exports, the rate at which growth is taking place is not strong enough to make any real impact on the unemployment rate. Additionally, the rate of inflation is falling perilously close to the zero rate, triggering the fear that deflation may set in. Central bankers fear deflation more than they fear inflation and thus “the Governing Council reviewed the forward guidance provided in July and confirmed that it continues to expect the key ECB rates to remain at present or lower levels for an extended period of time”.

In keeping rates so low – perhaps artificially low – central banks are providing the perfect backdrop to help governments reduce their cost of borrowing to such an extent that it allows them to lower their overall debt levels.

For other issuers of bonds, the impact is similarly positive. We are seeing this trend emerge very clearly in Malta. Not only is the government making use of the favourable environment to issue longer dated bonds at even lower rates of interest, but private issuers have been rolling over their bonds at lower rates. This is bound to continue for some time to come. But this is also extremely unfair on savers. It is especially painful on pensioners who see their income dwindle just at the point when they need it most.

The latest cut in interest rates is likely to exacerbate this position as banks are probably going to reduce the deposit rates even further. Interestingly enough Draghi also mentioned that the ECB is “technically ready” to impose negative interest rates on deposits. The implications of such a move are indeed far reaching and, in some ways, draconian. Think about it: a depositor would have to pay the bank for keeping its money rather than the other way around. It is not surprising to see investors scramble for any yield they can get their hands on.

Not only is the government making use of the favourable environment to issue longer dated bonds at even lower rates of interest, but private issues have been rolling over their bonds at lower rates. This is bound to continue for some time to come

The big question for this group of investors is how to preserve their level of income. In terms of an investment strategy, this is not an easy question to answer if you bring in the aspect of risk. Buying some of the corporate or government bonds being issued locally is one way of doing this. Other options may include buying other longer dated, or lower quality bonds instead, both of which normally offer higher yields. But they also carry higher risks, risks which many times investors ought not be taking, or else treating with extreme caution. High dividend paying equities could also be an option. This too carries its own risks.

The danger here is that locking your rates of interest for a long period of time may appear a sound strategy to adopt but it presupposes that you are indifferent to any price movements that may occur in the not too distant future.

Bond markets have been in a secular bull market for many years, and may continue in this way for a long time yet, especially if the ECB retains its stance of keeping interest rates low for an extended period of time. But bond markets do not only look at the ECB’s interest rate guidance. They will be influenced by other factors such as inflation expectations and also the actions of the Fed.

Earlier this year we saw how quickly, and violently, the markets moved when the Fed announced it will begin to taper. This may be indicative of things to come. Second time round, the Fed is likely to be more cautious and to manage its exit strategy more carefully but the writing is on the wall. Yields on bonds at some point must go up. And yields on European bonds will follow. The question is when?

Investors therefore must accept that at some point the bond cycle will turn and they will start receiving statements from their investment managers showing they are losing money on their bond positions. To what extent a client is prepared to stomach such losses could indicate the level of risk that an investor is prepared to accept. It is wise therefore to design an investment strategy today that gives you some protection in such a scenario while also providing the income required.

Lastly, I would like to wish farewell to our colleague and friend Joe Bonello who went to meet the Risen Lord last week. Joe was one of the founders of the investment industry in Malta and we will miss his contributions to the industry. His sudden departure was a shock to us all and my sympathy goes out to his family.

This article is the objective and independent opinion of the author. The information contained in the article is based on public information.

Curmi and Partners Ltd is a member of the Malta Stock Exchange, and is licensed by the MFSA to conduct investment services business.

David Curmi is the managing director at Curmi & Partners Ltd.