Interest rate cut: what do I do with my money now?

Interest rate cut: what do I do with my money now?

With interest rates close to zero, savers could be forgiven for giving up, and putting their cash under the mattress.

By Harry Wallop, Consumer Affairs Editor
Last Updated: 9:23PM GMT 05 Mar 2009

Corporate bonds are becoming increasingly popular. These are a form of IOU issued by large companies. The important thing is not to store it under the bed

What's the point of letting £100,000 languish in an account for it to earn all of £290 in interest in a year. And that's before tax.

But savers really should not despair at the average savings rates cited by the Bank of England. Canny investors need to shop around, hunt for better than average, and think about alternative places for their cash than a standard deposit account.

For starters, there are some cash Individual Savings Accounts, that are offering well over 3 per cent, such as Marks & Spencer's 3.1 per cent, which savers can withdraw their money from at any time. The advantage with ISAs is that they are more or less tax free, though savers can only invest up £3,600 each year.

For those with more cash, and the discipline to deposit money regularly, they can enjoy an astonishingly good rate of 5.84 per cent from Barclays – more than tenfold the new Bank Rate. The down side is that you have to put in at least £20 every month but no more than £250.

Further afield from traditional banks, there are endless possibilities.

Corporate bonds are becoming increasingly popular. These are a form of IOU issued by large companies. (Take a look at Barclays corporate bond.)

They are not risk-free and tend to pay higher returns than deposits to compensate investors for a lower degree of security; for example, British American Tobacco bonds due to be redeemed in 2019 currently yield – or pay out the equivalent of an annual return – about 6.4 per cent, while Tesco bonds pay 5.5 per cent. And Tesco is still likely to still be around in 2019 to pay investors back.

Or you can always turn to the last refuge of the desperate: gold, which is proving a volatile, but impressive, performer during the financial crisis.

You can buy the stuff via gold exchange traded funds, which trade on the stock market like shares, or pop down to a bullion dealer and buy a bar or coin of the hard stuff.

The important thing is not to store your savings under the bed.

The only winner will be the local neighbourhood thief. And as the police have warned, they are on the increase – unlike interest rates.


http://www.telegraph.co.uk/finance/personalfinance/savings/4944354/Interest-rate-cut-what-do-I-do-with-my-money-now.html

Savers are going to bear the brunt of the Bank of England's attempts to revive the economy

Mervyn King suggests savers will be sacrificed as rates fall
Savers are going to bear the brunt of the Bank of England's attempts to revive the economy, the Bank of England Governor Mervyn King has warned.

By Myra Butterworth and Edmund Conway
Last Updated: 4:35PM GMT 11 Feb 2009

Comments 27 Comment on this article

Mr King expressed sympathy for savers, but indicated that they will be sacrificed as interest rates are cut further in a bid to revive the economy.

He said: "I have every sympathy with savers – they are certainly not responsible for the current difficulties – but suppose we were to put up interest rates?

"That might benefit savers in the short run, but is anyone seriously suggesting that would help the British economy get through the recession? No. We have to take action to increase the supply of money in the economy, to increase spending in the short run, in order to dampen the strength of the recession."

The Bank of England is widely expected to reduce rates to zero per cent at its next meetings in March or April.

Mr King explained: "Given that we are in such a deep recession in the short run, I think that if we were not to take measures to stimulate the economy, then savers would find they are actually much worse off – there would be even higher unemployment and even more of a downturn in the economy. That is the paradox of policy."

The Bank of England has cut the Bank Rate from 5 per cent to just 1 per cent in the past five months – and high street banks have responded by reducing the rates they offer savers.

Savings rates are now at their lowest ever level, according to the Bank of England's own records, with notice accounts offering an average of just 0.29 per cent and cash individual savings accounts (Isas) paying an average rate of 1.38 per cent.

Financial experts and charities warned lower rates will bring further misery to savers this year.

Sean Gardner, of the personal finance website MoneyExpert.com, said: "The Bank of England has tried to jump start the economy by slashing interest rates to previously unheard of lows. But these efforts come at a price and it's savers who have been sacrificed.

"Savers outnumber borrowers seven to one and it's the returns on their hard earned cash that will be crushed every day that the base rate stays so low."

Rebecca Ward, of the poverty charity Elizabeth Finn Care, said: "The latest interest rate reduction is a further kick in the teeth for people on low incomes who are struggling to eke out from their savings a life beyond mere subsistence survival."

Mr King's comments come as The Daily Telegraph calls for pensioners to be given a tax cut on the income earned from their savings and investments through its Justice for Pensioners campaign.

The Chancellor, Alistair Darling, has said he will look at measures to help these savers in the Budget, due in March or April.

Phil Jones, personal finance campaigner at consumer group Which?, said: "We've seen some very worrying data and savers will be very concerned. Banks cannot have their cake and eat it: if banks are not passing on cuts to borrowers they should not be passing on cuts to savers."

http://www.telegraph.co.uk/finance/personalfinance/savings/4592271/Mervyn-King-suggests-savers-will-be-sacrificed-as-rates-fall.html

What we do when interest rates fail

What we do when interest rates fail
Mervyn King sets out the future for monetary policy, writes Edmund Conway

Last Updated: 8:13PM GMT 20 Jan 2009
You know things have come to a pretty pass when the Bank of England Governor admits that his main tool for influencing the economy – the UK benchmark interest rate – is no longer working.
But that is precisely what Mervyn King did last night. In a remarkable speech, he told Britons for the first time to brace themselves for quantitative easing. His acknowledgement that the UK central bank will have to resort to this drastic new method – used rarely in the history of finance – is likely to go down as one of the landmark moments in the financial crisis.
Equally striking as his confirmation that the Bank may soon embark on a policy of directly pumping cash into the economy was his stark description of the scale of the current malaise. Activity and confidence throughout the global economy had "fallen off a cliff", he said, with shares in London falling at one of the fastest rates in history and exports and output from here to the Far East dropping dramatically.
It is only against such a backdrop that such drastic action is necessary, he said. The plan the Bank intends to follow bears some resemblance to the scheme already in place in the US. The Bank has been granted permission by the Treasury to spend up to £50bn on assets, which it will then keep on its books with a view to selling them off later. The assets, which include commercial bonds and asset-backed securities, will be bought off private investors in the secondary markets – but this time the Bank will give them cash in return for the investments. The result will be an expansion of the Bank's balance sheet. For those who really follow such things, this is not quantitative easing, but what Ben Bernanke recently described as "credit easing".
In Mr King's words, which are worth quoting at length: "The disruption to the banking system has impaired the effectiveness of our conventional interest rate instrument. And with Bank Rate already at its lowest level in the Bank's history, it is sensible for the [Monetary Policy Committee] to prepare for the possibility – and I stress that we are not there yet – that it may need to move beyond the conventional instrument of Bank Rate and consider a range of unconventional measures.
"They would take the form of purchases by the Bank of England of a range of financial assets in order to expand the amount of reserves held by commercial banks and to increase the availability of credit to companies. That should encourage the banking system to expand the supply of broad money by lending to the private sector and also help companies to raise finance from capital markets."
The new asset purchase scheme will in fact give the Bank two powers beyond the ability to expand its own balance sheet. The first is to influence the pricing of a particular species of investment. If it believes the markets for certain corporate bonds are frozen, for instance, it may concentrate on buying them to help improve liquidity.
Second, and perhaps most importantly of all, it can, with the permission of the Treasury, opt to under-fund the Government's budget deficit. This means selling off fewer gilts than is necessary to pay for the assets, and is similar to what Japan did in the late 1990s, and what the Federal Reserve has now moved onto now. This is real quantitative easing. Interestingly, however, Mr King was reticent on how and when such a move would take place. It is hardly surprising. This kind of central bank activity has the potential to be highly inflationary. That should not be an immediate concern, given that the UK is now facing deflation.

http://www.telegraph.co.uk/finance/comment/edmundconway/4299635/What-we-do-when-interest-rates-fail.html

How do central banks inject money into the economy?

Investment Question
How do central banks inject money into the economy?

Central banks use several different methods to increase (or decrease) the amount of money in the banking system. These actions are referred to as monetary policy. While the Federal Reserve Board (the Fed) could print paper currency at its discretion in an effort to increase the amount of money in the economy, this is not the measure used.

Here are three methods the Fed uses in order to inject (or withdraw) money from the economy:

1. The Fed can influence the money supply by modifying reserve requirements, which is the amount of funds banks must hold against deposits in bank accounts. By lowering the reserve requirements, banks are able loan more money, which increases the overall supply of money in the economy. Conversely, by raising the banks' reserve requirements, the Fed is able to decrease the size of the money supply.
2. The Fed can also alter the money supply by changing short-term interest rates. By lowering (or raising) the discount rate that banks pay on short-term loans from the Federal Reserve Bank, the Fed is able to effectively increase (or decrease) the liquidity of money. Lower rates increase the money supply and boost economic activity; however, decreases in interest rates fuel inflation, so the Fed must be careful not to lower interest rates too much for too long.
3. Finally, the Fed can affect the money supply by conducting open market operations, which affects the federal funds rate. In open operations, the Fed buys and sells government securities in the open market. If the Fed wants to increase the money supply, it buys government bonds. This supplies the securities dealers who sell the bonds with cash, increasing the overall money supply. Conversely, if the Fed wants to decrease the money supply, it sells bonds from its account, thus taking in cash and removing money from the economic system.

To learn more about central banks and their role in monetary policy, check out Formulating Monetary Policy.

http://www.investopedia.com/ask/answers/07/central-banks.asp?ad=feat_fincrisis

Impact of Interest Rates on Stock Prices

Impact of Interest Rates on Stock Prices

Warren Buffett highlighted the impact of interest rates on the Dow in a speech he gave on the stock market in July 1999. To demonstrate the correlation between interest rates and stock prices, with the exception of the inflation figures, he provided the data below which depicts two 17-year periods, between 1964 and 1981, and 1981 to 1998.

31st December
Gain in GNP over each 17 year period (%)
1964 – 1981…..373
1981 – 1998…..177
DJIA
1964—874
1981-- 875
1998--9181
Interest on long term government bonds (%)
1964-- 4.20
1981-- 13.65
1998-- 5.09
Increase in consumer price index over each 17 year period (%)
1964 – 1981…..201
1981 – 1998……74

Note:

The inflationary effect on asset values together with retained profits and new capital issues would have significantly increased the book values of the companies comprising the Dow during the first period 1964 – 1981. Yet, in spite of the huge increase in GNP, the 1964 index figure was basically the same 17 years later. Prices had been subdued by a more than threefold increase in interest rates.

In the second 17-year period from 1981 to 1998, in spite of GNP growth and inflation being less than 50 percent of the first period, the Dow increased by 949 percent. The driving factor was declining interest rates that diverted money out of interest-bearing securities into equities.

Interest rates increase at times of high inflation partly to offset the diminishing value of money and the government’s desire to curb demand in what is seen to be, as measured by GNP, a fast-growing economy. Conversely, when inflation subsided in the second 17-year period, interest rates declined.

Economic Impact of Interest Rates and the Japanese Economy

Economic Impact of Interest Rates
There is a tendency to forget that for every borrower there is a lender and that interest rates work both ways. Less interest paid by borrowers means less interest received by lenders. When interest rates rise or fall, total disposable income doesn’t change; it simply redistributes.

Effect of rising interest rates on consumers
1. Consumer demand declines because the forced reduction in consumption by the greater number of borrowers is greater than the increased consumption of the lesser number of lenders.
2. Reduced demand is said to dampen inflationary impact of rising prices.
3. Budget-strapped families are forced to work extra hours or family member to seek part-time work.
4. The subsequent increase in availability of labour reduces pressure on wage demands.


Effect of interest rates rise on highly leveraged businesses
1. Profitability of highly leveraged businesses is reduced by their high cost of debt. Main impact on profitability is felt by exporters.
2. More foreign capital inflows are attracted by the higher interest rates which increases the exchange rate, consequently reducing the value of exports in the domestic currency.
3. Lower export output means reduced demand for labour and consequent further restraint on wage increases.
4. Higher exchange rate also means that the lower cost of imports will reduce prices
5. Reduced labour demand in industries competing with imported goods stabilizes costs by again increasing the availability of labour.


Effect of falling interest rates
1. Debtors are rewarded and more inclined to be financially irresponsible.
2. Those who have been prudent in accumulating savings in interest-bearing securities are penalized and less inclined to be prudent in the future. (Given the impact of a 40 percent tax rate and 3 percent inflation on an interest rate of 5 percent, the zero return (5 percent x 60 percent – 3 percent) provides zero incentive for prudence.)
3. Although serving short-term political objectives and rescuing overleveraged debtors, the longer-term effects of artificially low interest rates have proven to be undesirable.

Low Interest rates and The Japanese Economy
Any doubt about the effectiveness of low interest rates to stimulate the real economy should have been dispelled by the well-publicised Japanese experience. In spite of having interest rates close to zero and the government running a huge annual deficit, thus leaving more disposable income in the hands of the consumers, Japan has suffered a lingering recession since 1990.


The Nikkei 225 index’s loss of one-third of its value in the past 20 years can only be attributed to the low profitability of Japan’s corporations. Even with the leverage of close to zero interest rates, the ROE of Japan’s large nonfinancial firms fell from 8.2 percent in 1988 to an average of 3.1 percent between 1992 and 1999. It has since recovered to roughly 10 percent in 2007, but still lags a long way behind higher-interest-rate countries.


The real determinant of economic viability, ROFE (Returns on Funds Employed), would obviously be considerably lower than the quoted ROEs. When debt servicing is of no concern, inefficiencies creep into the business and the economic viability of capex becomes less important.
The prices of those wonderful products we buy from Japan are subsidized by shareholders of Japanese corporations. Little wonder that Buffett, when asked about investing in Japan in 2007, wryly commented that the profitability of Japanese companies was too low for Berkshire’s liking.


Although Japanese corporate profitability is improving, by Western standards most of its major corporations have not been economically viable in the past, and if required to pay equitable rates of interest, would be in serious financial difficulty.


The high Nikkei index PE ratio in 2007 of 18 (price-to-book value of 1.9) on average ROEs of 10 percent is influenced by the meager average dividend yield of 1.1 percent still being better than leaving money in the bank.


With so little incentive to invest and debt so cheap, it is not surprising that in 2005 Japan was the world’s largest consumer of luxury goods, accounting for 41 percent. Rather than working in favour of Japanese investors, low interest rates over the past 20 years have decimated their funds. Although low domestic rates persist, demand for Japanese stocks will remain high and they will therefore continue to be grossly overpriced.

The reason Japan keeps rates so low is to encourage an outflow of capital to dampen the yen exchange rate to help its exporters. In other words, domestic employment is the prime motivation. If Japan’s trade surplus were repatriated, rather than being left abroad, the US dollar would crumble and the yen appreciate to a level that would make life even tougher, perhaps impossible, for many Japanese exporters.

Here is a simple question to see whether you have been following the argument.
Given a Nikkei index figure of 16,500 and the abovementioned ROE (10 percent) and price to book value (1.9), what would the Nikkei index need to be to achieve a 10 percent return from an index fund that replicated it? Answer: 8684

When ROE and RR (Rate of Return) are equal, value is equal to book value. Therefore, 16,500 / 1.9 (price to book value) = 8684.

These are the sorts of things to consider when thinking about investing in international funds.


Related article: 20.11.2008 - KLSE MARKET PE

How do I gauge the trend of interest rate?

Question: How do I gauge the trend of interest rate?

Generally, the central bank of a country uses interest rates to control inflation. Therefore, an understanding of interest rate trend is important since it invariably affects the stock market.

Basically, the trend of interest rates tend to depend on several factors.

One of the more important factors concerns the growth of money supply, that is, by comparing M3 with the economic growth which is that of Gross Domestic Product (GDP).


Illustration.

Country "A" (Broad Money Supply M3) Year 1993

*Broad money supply (M3) = A + B + C = $38.3bn
Annual % change in M3 = 24%

GDP (Rate of expansion) = 12.6%

Base Lending Rate (BLR) Current = 7.1% - 7.25%

Conclusion: The economy is facing high risks of inflation as the M3 growth rate of 24% is twice as fast as the rate of expansion which is 12.6% in nominal GDP.

Possible Action: As there is likely to be a surge in inflation in the immediate future, an increase in the BLR to 8.5% is a possible move in order to bring M3 growth rate back to about 15%.

Effect: Interest rate in Country "A" could be on the rise.


_____________

*Broad Money Supply (M3) = A+B+C
The Determinants are:......................... 1993......... % change

A. Net Lending to Government..........1.6bn........-1.0%

B. Private Sector Credit Demand........18.1bn......11.3%
Manufacturing...................2bn....+1.2%
Construction....................1.3bn....0.8%
Commerce.......................1.8bn....1.0%
Transport........................2.2bn....1.4%
Other Business...............1.0bn....0.7%
Personal...........................9.8bn...6.2%

C. External Liquidity.........................21bn......13.7%
Traders & Income
Repatriation........-5.4bn....-6.0%
Investments..................11.7bn....8.4%
Short Term Funds........15.5bn...11.3%


Ref: Making Mistakes in the Stock Market by Wong Yee

Foreign exchange risks

The roles of the central bankers and the governments are to ensure reasonable GDP growth, to manage inflation and to keep unemployment at a low rate. At anytime, their policies will be driven by the targets they choose to focus on. These can be done through fiscal and monetary policy.

The NZ and Australia government have both chosen to stimulate the growth in their economies by reducing interest rates. Their action will translate into weaker NZ and Australian dollars. Similarly, the interest rate in UK has been reduced to stimulate its weakening economy. The property prices in UK has also fallen by 10% to 20%. Japan has grown its GDP the last 5 years, but this year is likewise facing headwind given the downturn in the world economy. The yen is expected to weaken this year.

The Euro is expected to gain in strength since the ECB has chosen to control inflation by increasing its interest rate. China yuan is expected to continue to strengthen this year. The US dollar decline is not expected to continue and probably has bottomed recently. It may even strengthen slightly going forward.

What of the Malaysian ringgit? Due to the recent large hikes in oil price and electricity tariffs, the Malaysian inflation is at a high at present. This is expected to attenuate going forward. GDP is expected to slow down from 5% - 6% to 4.5% - 5.5% for this year. At present, the central bank has not felt the need to temper with the interest rate given the inflation expectation is not a problem presently. Nevertheless, the cost for borrowing for the public has increased.

My guesses are the UK pound, Australian and NZ dollar and Japanese yen are expected to weaken. The Euro, Chinese yuan and probably the US dollar, are expected to strengthen.

How will these various currency movements affect the KLSE counters that have significant business overseas? How will these movements affect capital flows seeking higher investment returns in the world?