Interest Rates in the UK

Interest rates are a tool that central banks use to implement monetary policy. They represent the percentage rate at which interest is paid by a borrower for the privilege of using money that has been lent to them and the interest can be paid at various time intervals. Higher interest rates will have an impact upon inflation and employment and could lead to a reduction in consumer spending and investment. The Bank of England meets every month to set the UK bank rate. There are nine members of the Committee and they are appraised of all the latest data on the economy and business conditions. Their task is to keep inflation below 2% but above 1% in the following 2 years.

In the UK the current rate of interest, also known as the base rate, as set by the Bank of England, is 0.5%. This is an historically low level which has been in place for the past 5 years in order to aid the country's recovery from the recession brought about by the financial crisis. It is anticipated that interest rates will have to rise sooner rather than later, although there is much speculation about the date of the first rate rise which is anticipated to be in the first half of next year. The new normal level for rates is expected to be 2 to 3%, well below the 5% from the late 1990s to the financial crisis. In 1976 interest rates hit 15% and double digit interest rates were not uncommon between 1975 and 1991.

Mark Carney, the governor of the Bank of England, and Charlie Bean, the outgoing Deputy, have both indicated that rates will peak at around 3% in 3 to 5 years time, below the pre-crisis average of 5%. There have been indications that rates may start to rise in the next 12 months and in the latest minutes of the Bank of England's meeting it seemed that a decision was now more finely balanced than in recent years. It is essential that the Bank of England raises rates slowly so that it does not choke off the recovery that is beginning to come through. Britain's economy is growing faster than any of the other Group of Seven countries at an annual rate of 3% and it is not clear what impact an interest rate rise would have on the economy after the long recession.

Charlie Bean has suggested that any rises are in "baby steps" in order to avoid making mistakes. In other words he thinks the Bank should be cautious - this could entail raising rates soon - but at a smaller rate than has been implemented in the past, for instance at a rate of increase of 0.1% instead of the previous normal rate of 0.25%.

It is generally accepted that low interest rates are inflationary and the Bank will be watching for early signs that this is happening and try to move interest rates up early to forestall it. Generally they would raise interest rates if they were concerned that inflation was on the increase in order to reduce demand and slow the rate of economic growth. At the present time there are no signs that inflation is picking up with the latest CPI figure coming in at 1.8% which may be attributable to the output gap.

Interest rate movements have the largest impact for individuals on savings, mortgages and annuities, whilst for businesses it impacts the level of demand, interest on loans and the present value of assets and liabilities.

Over the last 5 years savers have been badly hit by the low level of interest rates. This has been particularly hard for pensioners with savings. Higher interest rates would make it more attractive to save cash in deposit accounts as the level of interest received would be higher than at present, thus reducing the need to take on extra risk to earn a decent reward.

At the same time interest payments on credit cards and loans would increase making them more expensive to use and would act as a disincentive. Those who have existing loans may find them harder to finance due to higher interest payments and this could reduce their spending in other areas.

In Britain there have been concerns about the housing market recovery and the possibility of a bubble forming, particularly in London. The Bank of England will be more concerned about the risks of a large increase in debt than about price growth due to a lack of supply. If interest rates rise mortgage payments linked to the variable rate will also rise and new mortgages will also be issued at a higher rate. This would also have the impact of a brake on spending as disposable income would be reduced. For instance a 0.5% rise in interest rates would increase the payments on a £100,000 mortgage by £60 a month.

Annuity rates have been very low during the financial crisis as they are linked to interest rates via the 15 year gilt or government bond yield. When interest rates rise annuity rates should also improve. Those retiring in the coming years should be able to secure a higher income. A half a percentage rise in interest rates could see yields on the 15 year gilts rise by 50 basis points which could result in a 5% rise in annuity rates whilst if interest rates reach 1.75% annuity rates could be 12.5% higher.

The value of sterling would increase if interest rates rose. International investors would be more likely to use British banks for their savings if the interest rates in the UK are higher than in other countries.

A strong pound also makes British exports less competitive which could have the effect of reducing exports and increasing imports thus reducing the overall demand in the economy.

Interest rate rises also have the general effect of reducing confidence both for the consumer and business which has the effect of discouraging risk taking and investment.

Predicting when rates are likely to increase is difficult. One indicator that may help to predict when interest rates are likely to rise are the overnight swap rates which often influence the market rates of fixed mortgages and fixed rate savings bonds.

Darren Winters

International Economic Statistics

Europe chose to resolve the financial crisis in 2008 with a programme of austerity for the peripheral and weakest economies while the US and UK chose to recharge their economies with quantitative easing.  Both also increased controls over the banks and brought interest rates down to an historically low level.

So how has the different approaches affected the current economic performances of the countries involved? 

In Europe the result has been to improve the performance of the peripheral economies and to regain investor confidence in the robustness of the European monetary system.  This approach has been successful but has resulted in lower anticipated growth in the next couple of years from the two main northern countries with German and French GDP growth forecast by the IMF to be 1.7% and 1.0% respectively in 2014 with 1.6% and 1.5% forecast for 2015.  Italian GDP on the other hand is forecast as 0.6% in 2014 and 1.1% in 2015 following the austerity measures forced upon it in order for it to qualify for financial support.  

In the UK comparable figures from the IMF are for GDP growth of 2.9% and 2.5% for 2014 and 2015 respectively.  In the US they are forecasting 2.7% and 3.0%.

In Japan forecasts for GDP growth in 2014 and 2015 are for 1.3% and 1.0%.

Japan went through a similar financial crisis in the early nineties and has suffered stagnation since then with falling prices and increasing government borrowing.  They have responded recently under Mr Abe with a quantitative easing programme of their own which, coupled with an austerity programme of fiscal reform and talk of fundamental reform was to develop their own recovery from this period of stagnation.  It is early days to judge the result but some growth is forecast in GDP which is a positive sign and a determination to extricate themselves is clear.  Although the fundamental reforms are proving hard to achieve, inflation is forecast to be 2.8% this year as it has been given a boost by the introduction of a sales tax last month of 15%.  An inflation figure of 1.3% forecast for 2015 is progress.

The fear is that, in the absence of a monetary stimulus programme on the lines of that followed in the US, Europe will go down the same route as that followed by Japan in the nineties and experience low growth and deflation.  The forecast for inflation in 2014 is 0.8% followed by 1.2% in 2015 which, if achieved, will avoid deflation, but is regarded by many independent economists as too optimistic. Talk of a stimulus programme by Mario Draghi to combat this risk is thought to be his attempt to talk down the currency (a high currency leads to lower import prices and lower inflation) without actually introducing the stimulus.  The Germans remain very opposed to any such action as it is regarded as a way to avoid the reforms needed in the Southern economies and, perhaps, France and that it could lead to unacceptably high inflation in the future.

The UK and US have followed very similar paths from an early date with major programmes of quantitative easing, low interest rates and a programme of cutting government expenditure.  The result has been faster economic growth but without any adverse reaction detectable in the inflation figures which are forecast to be 1.9% in 2014 and 2015 in the UK and 1.4% and 1.6% in the US.

The result of these responses to the financial crisis can be seen in recent statistics with demand for housing and retail products rising sharply in the UK and US while consumer confidence in Europe remains low.  

In the UK house prices rose 8.9% on average across the country according to Rightmove.  Inflation was marginally higher than anticipated at 1.8% aided by the strength of Sterling over the last year which was up nearly 10%. This strength has dampened hopes for strong UK export growth as seen in the latest figures which revealed a fall of 1.0% over the last quarter.  On the other hand imports fell by 1.1% with the dampening effect of higher Sterling on import prices contributing to the slowdown. An increase in consumer confidence is reflected in higher house prices as is the strong retail sales figures which rose 6.9% on the year aided by improving weather and wages which rose in line with inflation. The Bank of England revealed the minutes of the MPC which reflected unanimity for retaining low interest rates.  The Governor reiterated their determination to retain interest rates at a low level until well into next year and to tackle any threat from rapidly rising house prices by using ‘other tools’ such as a reduction in the ‘Help to buy’ programme and tighter criteria for lending. The CBI’s survey on industrial trends revealed a disappointingly flat trend, however, the UK seems to be growing faster than forecast, as GDP came in at 3.1% aided by a continued strong performance from the services sector up 0.9% in the March quarter and a recovering trend for capital investment which was up 8.7% over the year. Government borrowing came in lower for the year ended April 2014 and in line with plans.

There was a similar story from the US where the minutes of the FOMC meeting were published and followed by speeches from various Federal Reserve officials including Janet Yellen who reiterated their continued dedication to low interest rates and to ‘tapering’ the rate at which they pump money into the US economy.  Their fear is that the recovery in the housing market will stall should interest rates rise as a result of them ‘tapering’.  Existing home sales, however, remained at healthy levels with a rise of 1.3% in April over the previous month and new home sales rose 6.4% over the same period.

In Europe manufacturing in Germany maintained some growth with a figure of 52.9 (above 50 is growth) but this was lower than the previous month’s 54.9. In France, on the other hand, they continue to be in the doldrums with a figure of 49.2 after a higher figure in the previous month of 51.2.  European consumer confidence remains low with a fall of 7.2 in May but was a slight improvement on the fall of 8.6 in April.  In Italy industrial orders returned to growth with an increase of 2.8% over the last year.

Short term the Anglo Saxon countries are performing best but without much more success improving the fiscal balances as a percentage of GDP the long term result may be totally different.

Darren Winters

Forex Economic Calendar - Outlook for 26th - 30th May

Monday May 26 the week starts with UK Nationwide House Prices (year on year to May). Mortgage data is used to give a current level of prices. This is a useful gauge for traders to determine the costs of homes in the UK and the state of the housing market, which in turn can also give us a clue to some important macro economic factors, such as the rate of inflation and unemployment. There’s a positive correlation between the health of the housing market and employment. The rationale, being that higher prices, in keeping with the laws of supply and demand, acts as a signal to constructors to increase their activities. Bearing in mind that construction is labor intensive we can then deduce that a buoyant housing market could also have a positive impact on employment. Moreover, if construction is incentivized, through higher housing prices this could also increase the demand for building materials, bricks, cement, copper(electric wiring), steal, wood, ceramics, piping etc. 

However, because there is a time lag, between the demand for dwellings and the time it takes for constructors to build them, if supply doesn’t respond quickly enough to the buoyant demand for properties this could also exert pressure on housing prices. Indeed, there are some concerns from the Bank of England that the availability of relatively cheap

 credit and the Government’s help to buy scheme may be creating another housing bubble.

So if UK housing prices come in at above expectations, we may start seeing a new trend in UK interest rate rises, which could be implemented by the Bank of England with the intended goal of cooling the property market. The extent to which these potential rate rises could occur would most likely depend on the strength of the UK’s economic recovery in the coming months ahead.

 Assuming the figure comes in high and the Bank of England decides to raise interest rates, the impact on the FOREX market would be fairly predictable; hot money would flood into sterling, in search of higher rates of return. In short, this could lead to an appreciation in UK sterling, as traders sell other denominated currencies, such as Euros, dollars, yen and then buy sterling. Equally, foreign currencies that have been exchanged for sterling could also depreciate. However, the extent to which we see these movements in the FOREX market depends on whether the market has already anticipated higher than expected UK housing prices and the corresponding interest rate rise that could ensue. A sterling Vs dollar chart showing resistance and support levels could be useful in determining whether potential interest rate hikes have already been factored into sterling’s price.

Onto the euro land, Germany retail sales is out on Tuesday (month on month figure), May 27. This data measures the monthly changes of sales in the German retail sector. From the data we can determine the state of the German consumer. It’s also a good indicator to estimate changes in German GDP, bearing in mind that consumption makes up a large proportion of German growth. High retail sales may spur on consumption and economic growth.  Since Germany is the main player in the euro zone, German figures could have some impact on the market. The headline figure is expressed in percentage change in the value of sales. If the figure is positive it would be an indication that economy is ticking over nicely, which could result in a corresponding appreciation in the euro and an equal depreciation in other

currencies.  But it is worth noting that German retail sales decreased 0.7% m/m in March. This trend may continue bearing in mind that there are some pressures on real wages. 

Swiss Gross Domestic Product (GDP) measurement year on year figure is also out on Tuesday. GDP is the value of all final goods and services produced within the nation's borders. However, this figure is unlikely to be a big mover on the Forex market.

US Durable goods data will also be published on Tuesday, which is a relatively market sensitive data. Durable goods are those expected to last for more than three years for example, cars, televisions, white goods and they usually require large investments or financing. An increase in durable goods data is interpreted as an increase in optimism in the economy. A positive durable goods data from the US could provide tail winds for the dollar. 

On Wednesday May 28 German Unemployment figures and euro zone confidence data will be released.  The euro zone confidence data is an overall gauge of sentiment toward the economy in the Euro-zone. The index is a composite of most of the sector specific surveys done by the European Commission. A high or rising level of Economic Confidence indicates healthy levels of purchasing, business spending, and investment.  An upbeat economic outlook indicates a strengthening of the economy and with that the Euro.    

On Thursday May 29, traders will be eagerly waiting for the second estimate, based on more complete data, for the first quarter  US GDP figures . GDP from across the pond have a high impact on the financial markets. Positive GDP figures could propel the dollar against a basket of other foreign currencies. Uk consumer confidence index will also be released on Thursday.

Finally, the week closes, Friday May 30 with US Michigan Confidence for May. This relates to US consumer confidence regarding personal finances, business conditions and purchasing power based on hundreds of telephone surveys conducted by the University of Michigan.

There could also be unforeseen future events that may influence the forex market in any given week, natural disasters, geo-political events, terrorist attacks etc. These black swan events are virtually impossible to predict. The aim for the trader is to engineer a maximum tolerance to risk in his trades, to use a combination of tools to assess whether the market sensitive event has already been factored into the currency. Moreover, to use his training/experience and tools to determine buy and sell signals. For those top at this game the rewards are huge.

Darren Winters

Pfizer - Astrazeneca - The failed Takeover

The failed AstraZeneca takeover affair may be a stark reminder that there are just a few players who actually influence the outcome of a mammoth Takeover bid involving corporate titans.   They are the board directors, the shareholders (fund managers and institutional investors) and the suited and booted brigade in Whitehall, the government.  These players, the stakeholders in the business, more often than not have interests which conflict. The shareholders want shareholder value and a tidy return on their investment; a non-executive board may have their own goals of self-enrichment to the detriment of the shareholders. On the other hand, the government may view the entity as a tax revenue cow. Moreover, if the business contains valuable intellectual property, patents and provides local jobs the government is unlikely to rubber stamp it being taken over by a foreign rival, on the grounds of national interest.

So with all this in mind it probably came as no surprise that when Pfizer, US pharmaceutical giant, upped its failed bid to approximately 93 USD a share for its British rival AstraZeneca, it has created a political hot potato. Pfizer’s latest failed attempted to take over its British rival has valued AstraZeneca at $116 billion USD, which would be 19 times its projected 2015 earnings. Had the bid succeeded it would have created the world’s largest pharmaceutical company. But Pfizer was not prepared to put more money on the table.  AstraZeneca’s board remains adamant that the company is worth more and rejected the bid on the grounds that Pfizer’s latest offer still undervalued the pipeline of drugs that the company owns, particularly in the field of cancer medications. Well, this may be a vote of confidence for AstraZeneca’s potential future earnings, but the immediate effect was to send the share price tumbling 12 percent.  

Predictably, the shareholders are up in arms, lamenting about the profits they could have bagged. Investment management firm Schroders, which has a 2% stake in AstraZeneca and one of the pharmaceutical company's 20 largest investors, said it was disappointed with the failure of both companies to hold constructive talks.  The fund manager for Schroders added that he "would encourage the AstraZeneca management to recommence their engagement with Pfizer and subsequently their shareholders" and he was critical about AstraZeneca’s board’s decision to rapidly reject Pfizer’s latest offer.
Similar frustrations was also echoed by both Axa Investment Managers and Jupiter Investment Management, which represented AstraZeneca’ s other large shareholders. One top share holder complained, saying, “"we do not think the Astra management have done a good job on behalf of our shareholders," according to a recent report in Reuters.

Nevertheless, the British Government thinks otherwise on the AstraZeneca affair. Indeed, already UK ministers have begun exploratory talks with EU officials over amending the terms of the British government’s public interest test, which currently enables ministers to block Takeovers where there are concerns over national security, media impartiality or competition. Indeed, as I write this piece Minsters are currently reviewing whether to extend the test to ongoing investment in research and design as grounds on which the government could choke off a takeover.


But there may be more than meets the eye to Pfizer’s intended takeover of AstraZeneca. In other words, the big story here may be more than just a huge US pharmaceutical striving for global domination through the acquisition of a foreign rival.  After all, Pfizer has a multibillion dollar cache, so why isn’t it using this hot money to grow its business organically, instead of opting for growth through acquisition?  Perhaps tax engineering is playing a role in Pfizer’s foreign acquisition ambitions.  Indeed, the UK’s relatively lower tax rates compared with those across the pond maybe behind the acquisition. So financial engineers, these days, are burning the midnight candle scheming ways of inventing paper wealth by changing a company’s domicile to a lower tax regime. Take for example, Apple, it has a cache of approximately 150 billion USD, of which 130 billion USD is held in tax havens.

Repatriating the cash would result in a tax liability of 35 percent. “To repatriate our foreign cash under current U.S. tax law, we would incur significant cash tax consequences and we don't believe this would be in the best interest of our shareholders,” said Apple’s chief financial officer.
Likewise, if Pfizer's acquisition had been successful and it had moved its head office to the UK, analysts estimate the combined company's tax rate would have fallen to 23% from Pfizer's current 27%, a sizable amount when billions of USDs are involved.

Maybe all this is making Britain’s prized companies vulnerable to takeovers from across the pond. The climate seems ideal for it, the tax disparities between the UK and the US and moreover the availability of cheap money from the Federal Reserve who maybe even aiding and abetting it.   

What next for Pfizer?  Well, they could bypass AstraZeneca's board and go directly to the shareholders, thereby mounting a hostile bid. Alternatively, Pfizer could use its large cache to mount another bid for another pharmaceutical company, but the potential target company is likely to be outside the US for tax reasons.
For AstraZeneca, the pressure is now on for the board to materialize the profits from their drugs in the pipeline and prove to their shareholders that the company is worth more than 19 times project earning in 2015. Shareholders will be impatient to see the benefits of turning down short term profits for long term gains.

The road ahead looks interesting, after all, everyone has their price and even big money can sway a government.  For private investors there are opportunities in this market if they can spot potential targets, buy into them, sit tight, wait for a predator and then just ride the money wave. 

Darren Winters