With the uncertainty from Brexit already affecting the UK economy, it's looking likely that interest rates will be cut in the near future. Both Bank of England governor Mark Carney and Chancellor George Osborne have hinted that fresh stimulus could be on the way to help shore up confidence and some analysts believe interest rates could be cut to 0.25% as soon as next week.
Clearly this is bad news for savers and those relying on bank interest to generate an income stream. However a rate cut should be good for high-quality dividend-paying stocks as their dividends will look more attractive in relation to the measly rates on offer from the banks.
Here are three dividend champions that could provide portfolio protection in the event of an interest rate cut.
Healthcare giant GlaxoSmithKline (LSE: GSK) has several key attractions in the current environment.
It's in a defensive sector as demand for healthcare services isn't highly correlated to the state of the economy and as a result, healthcare stocks can hold up relatively well in an economic downturn. This explains the high demand for GlaxoSmithKline shares since the Brexit result with the stock jumping around 14% in under two weeks.
While the spike in the share price has pushed GlaxoSmithKline's dividend yield down, it's still a high 4.85%, which trumps any bank term deposit rate available. Investors should bear in mind that the company's dividend payout isn't fully covered after revenues have stalled in the last few years. However with the company generating much of its revenue overseas, including 30% of sales in the US, I expect GlaxoSmithKline to remain a popular stock while interest rates are low.
Utilities to benefit
An interest rate cut should also draw attention to the utilities sector. Utility stocks perform like bonds at times and generally have an inverse relationship to interest rates. The reason for this is that the utilities industry is extremely capital intensive, with many companies operating with high levels of debt. When interest rates rise this debt becomes more expensive to service and when rates fall, the debt is less of a burden and enhanced profits flow through to shareholders.
For this reason, shareholders of National Grid (LSE: NG) could benefit in the event of a rate cut and the power giant has soared in the last week as investors have scrambled to reposition their portfolios after the Brexit result.
National Grid has performed exceptionally well over the last five years, with shareholders enjoying annualised gains of over 18. And with a current dividend yield of 3.8% and an excellent track record of increasing its dividend, National Grid should continue to perform in the low interest rate environment.
Defend your portfolio
I also expect defence specialist BAE Systems(LSE: BA) to be a popular stock in the face of declining interest rates.
Unlike many other defensive stocks that are now trading on high valuations post-Brexit vote, BAE appears to offer value in my opinion as the stock is trading on a P/E ratio of just 13.8 times next year's earnings.
With only 23% of sales coming from the UK, BAE Systems should also benefit from weaker sterling, and with a formidable dividend yield of 3.9%, the defence giant should appeal to investors looking for income.
Edward Sheldon owns shares in GlaxoSmithKline and BAE Systems. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.