Will interest rates rise & sterling continue to depreciate?

Posted on: 27 October 2009 by Mark O'haire

Independent financial advisor Peter McGahan believes the economy isn’t far from turning the corner and away from the current recession.

Six months ago I would have said no to both questions but it's slightly different today. Quantitative easing is probably the biggest driver for this which in turn links to inflation. News that the economy is still in recession will not assist savers as rates will need to remain lower to support the economy. The figures regarding the economy are, however, an estimate and will be revised and I suspect will be revised upwards as I believe that quantitative easing will soon kick in and provide a support to the economy.

The current very low base rate is probably only there to really support bank's reserves and is having little real effect as most banks have not passed this saving on.

Indeed it is crippling building societies who are not fixed to the Bank of England base rate. Some building societies do not have the benefit of borrowing at a base rate of 0.5% and lending at 4.5% like banks do, instead they rely on borrowing from savers and lending to borrowers and that margin is much tighter at today's levels.

However interest rates could probably rise by another 2% and it will have little or no impact on the borrower but it will squeeze the margins that banks have although I suspect by next May, in time for the election, this will not matter. Savers will be happy and in turn will have the extra 2% and borrowers will hardly notice as many of their loans are collared at a higher rate.

All in time for an election. Watch out for inflation which I suspect may surprise on the upside come Spring. This will put a higher pressure on interest rates. It’s a difficult call but I suspect inflation will pick up early next year and interest rates will rise with it, but the latter will be closer to next October.

I have noticed various products springing up with financial institutions who are offering fixed rate bonds for one to two years. This (cynically) implies to me that they take an upward view on rates, so if you are a saver, I am of the belief that fixing now may not be the most advantageous idea given the threat of inflation, so look closely at that.

Australia is already in an earlier phase with its interest rates and is tightening them.

In the UK there are deflationary pressures on wages, and unemployment is clearly one of them, but this is expected to peak mid next year.

Whilst there is fear of unemployment, consumers do not spend, and employers can depress wages (justifiably) to minimise the impact on their organisational profits. Why do wages always have to be reviewed upwards?

As for Sterling, well I would have believed last year that it would have turned to a more positive mode but I am wrong with that. In the very short term you should be aware there are some very large short positions built up around sterling (investors have placed large bets that it will depreciate).

The weakness of Sterling or any currency is largely attributed to capital flows. Sterling and the dollar are economies that require large cash inflows but are running considerable current account deficits.

Whilst the faster growing economies are currently attracting the capital, the UK's damaged financial system is less than magnetic so sterling will be under pressure for some time to come. Once again, watch for mid-2009 post-election, as a number of factors fall into play. The UK is still a large exporter (pharmaceuticals, services etc) despite the fact that many think 'they make no cars'.

The weak sterling is probably by design and makes imports less attractive along with exports more attractive. This will be of considerable benefit to the UK economy.

However, on the flip side, Far Eastern companies have responded to this currency risk by marking down prices on their exports to retain the business which is a double whammy to the UK - bigger threat of deflation and still capital outflow to the East.

By Peter McGahan

Need Expert Advice?

Peter McGahanPeter McGahan is an Independent Financial Adviser and Managing Director of Worldwide Financial Planning. Worldwide has won 16 Financial Times awards in the last four years. Peter has also been named the top media IFA of the year by Unbiased.co.uk in 2009.

Peter comments regularly in major journals such as the Mail on Sunday, Irish News and Sunday Times and is a weekly columnist for FT Adviser. He has also appeared on Working Lunch and the Today programme. In addition he is an expert on international tax matters for a range of international publications.

Worldwide Financial Planning Ltd are authorised and regulated by the Financial Services Authority. 'The FSA does not regulate Credit Cards, Will Writing and some forms of mortgage and Inheritance Tax Planning.'

Information given is for general guidance only, and specific advice should be taken before acting on any suggestions made. The above represents the personal opinions of Peter McGahan. All information is based on understanding of current tax practices, which are subject to change. The value of shares and investments can go down as well as up.

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