How Low Should Interest Rates Go?
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Trading Features / Strategies from Simon Denham of Capital Spreads.
Rate Cut (?) day and the BoE must decide whether to slice another piece off the cost of borrowing. The current rate at 1.5% is the lowest in the 315 year history of the UK’s central bank but, forgive me for saying it, this is yet another indication of the modern habit of resorting to knee jerk reactions over immediate events.
Times are tough but not that tough and even in my life time I can remember much grimmer periods. If you compare events now to the history of Great Britain it is difficult to get a proper perspective on the management of the financial crisis by the various financial authorities.
The corporate bond market issued more debt in January than in the past 18 months as funds searched out for ‘reasonable’ returns and companies paid up to get their borrowing requirements finalised as soon as possible.
If the bond market is back to its normal issuance levels then there is a strong argument that Interest Rates should not be falling further but actually considering hiking as the ‘green shoots’ do indeed seem to be arriving. Unfortunately this is only one sign of a return to normalcy and we still have the full momentum of a slowing economy to turn around.
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Low rates were also supposed to be an attempt to get more liquidity into the markets but this was always an argument that I found difficult to understand. Yes, low rates make it easier for central banks to issue debt (of which there is soon to be a mind boggling sum). However it is hardly going to tempt funds or banks to lend more. I might lend to get a return of 5-10% but I would be wary of taking the exact same risk (on the sum lent) for just 1-2%.
Japan has had ultra low rates for almost 20 years and much good it has done them. Their State debt levels are now so high (up to almost 200% of GDP according to the IMF) that they could never afford rates up in the 5% range as interest payments alone would swallow up to 10% of GDP.
This is one of the strange conundrums of the strong Yen. It is argued that the pound is weak because of the level of debt that will be issued in the next five years. Much as I hate to agree with ‘Our Gordon’ on anything, from a global viewpoint we do indeed have a low overall debt level which will, no doubt, increase. Nevertheless at least a sterling investor can be reasonably sure that rates will eventually go back up again.
For holders of the Yen 0-1% returns have become the norm. Of course, this is a long term view and is certainly not a recommendation of immediate Sterling buying.
The above comments do not constitute investment advice and neither Capital Spreads nor Clean Financial accept any responsibility for any use that may be made of them.
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'How Low Should Interest Rates Go?' edited by DB, updated 05-Feb-09
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