At the beginning of December 2007, bank base rate was 5.75%. Twelve months later it had almost halved to 3%, with further cuts widely anticipated. There are even suggestions that the rate could drop below 2%, the lowest ever level since the creation of the Bank of England in 1694. If you think that impossible, then look across the Atlantic where the US equivalent is already 1%.

If you are a borrower and if your lender passes through the interest cuts in full, ultra low base rates are good news. On the other hand, if you rely on deposit interest to supplement your income, a sharp drop in base rates is unwelcome. To make matters worse, many institutions have added to the fall in income by reducing their deposit rates by more than the decline in base rates. The end result is that for the same size of deposit, the monthly interest you receive in January 2009 could be less than half that of January 2008.

While short term interest rates have been falling, elsewhere income returns have been rising (see box).

UK Shares A corollary of the sharp fall in share prices has been a rise in dividend yields. As at 25 November the average yield on UK shares was 5.8%. There are two important points to note about this figure:

•  The yield is quoted net of 10% tax. If you are a higher rate taxpayer, you have an additional tax liability equal to a quarter of the net dividend. If you are a basic rate taxpayer, you have no tax to pay – 5.6% is what you will receive. Non-taxpayers cannot reclaim the 10% tax, so also receive 5.6%.

•  The yield quoted, like those found in most newspapers, is historic. This means it is based on dividends paid over the last 12 months. In the current difficult economic conditions there is no certainty that dividend payments will stay the same for the next year. The likelihood is they will fall, if only because most of the banks will not be paying any dividends in 2009.

Overseas shares Just as the yield on UK shares has increased, so too has the income available from overseas equities. The absolute level is normally lower than the UK, but the average yield on foreign shares is now around 4.1%.