Should We Have More Interest Rate Cuts?

Should We Have More Interest Rate Cuts?

Trading Features / Strategies from Simon Denham of Capital Spreads.

The FTSE’s 6 day winning streak has come to an abrupt end after yesterday’s 2.8% decline and the market dipping another 1% so far this morning. There’s clearly nervousness surrounding today’s interest rate decision from the BoE at midday today with the market expecting a half point cut to 1.50% but the City never being so split on what they think the MPC should do.

There are compelling arguments for everyone, whether you are in the dovish or the hawkish camp and the MPC has a very delicate balancing act. One thing is for sure and that is the decision will be split and the market will probably react more to what the Bank says rather than what the bank does.

On the hawkish argument is that cutting rates too much will only serve to hit sterling again (despite the fact that it has recovered 8% since its low against the euro a week ago) and too much of a cut will leave less in the armoury for further down the line. Other hawks argue that the Bank should wait for the next Inflation Report before being too aggressive with its cutting, which is due out on 11th February just after the February decision on rates is due. On top of this the hawks believe that the government should now look at offering boosting the money supply as another prong of attack to get the economy moving again.

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Finally, further cuts are becoming increasingly difficult for banks to pass on, but they have no problems is slashing saving rates. With the pressure coming from all angles to move in line with the BoE, what commercial banks that are left can barely charge anything for their money now which is why we see banking stocks continue to struggle. Keeping rates at the level they are now will at least mean banks can charge for lending their money and savers will have at least some reason to keep their money on deposit rather than under the mattress.

For the doves the arguments are simple – the economy is suffering worse than it ever has for the 60 years with hundred year old businesses crashing around us and unemployment is on the up. Whilst in my view the calls that interest rates will hit zero at some point are extreme, interest rates will have to come down further, possibly reaching a low of 0.5%, so why wait? Sterling’s recent small recovery may be undone by a bigger cut, but the ECB will have to follow suit soon bringing its base rate down from 2.50% to similar levels, so whilst we cannot discount euro/sterling hitting parity, it maybe short lived. Their decision comes next Thursday.

So who wins? In my view the doves as the hawks’ arguments can be easily quashed. The government has still got armoury left beyond the BoE’s rate making policy and waiting around for Inflation Reports is not as important as it was 18 months ago when we were all worrying about stagflation – now deflation is the real concern. Whilst savers may suffer now it probably the right time to take a little risk with a five year view and for those who have a large amount of savings on deposit other investment opportunities must becoming very attractive indeed.

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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Article provided / approved by Capital Spreads which is a trading name of London Capital Group Ltd which is authorised and regulated by the Financial Services Authority (FSA), FSA Register number 182110.

'Should We Have More Interest Rate Cuts?' edited by DB, updated 08-Jan-09

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