Is the 1.5% reduction a double-edged sword?

Bets in the City / Simon Denham / 07 November 2008 / Leave a comment

Daily View - 7th November 2008

So now we look to see what the effect of 3pc (and maybe more to come) will have on the general economy. Initially the immediate winners will be those in debt (of whatever form) and whilst the banks may not be able to pass the full 1.5pc on immediately the long term prognosis, if funds return to the mainstream financial institutions, should be encouraging.
Listening to the BBC Money Programme last night was an infuriating occupation as the Programme planners filled the seats with an array of politicians, whose knowledge of banking apparently appeared to be zero, competing with each other in telling the banks to 'unlock the purse strings' and 'reduce rates immediately' as they had been the recipient of so much of our (government) money.

Sorry guys BUT the banks, unlike the government, cannot just print money. To lend they must get somebody to lend to them. Unfortunately many wealthy individuals, pension funds, investment houses are just not happy with the long term viability of the UK banking system. It is all very well for the State to 'lend' vast sums to the financial institutions (at 12pc remember) but with no guarantees over deposits (aside from the personal £100k, or whatever, insurance) the big money is still fighting shy of lending to the institutions. If they do they want a hefty rate for the risk. With the Lehman experience fresh in everyone's minds would you lend solid cash to a bank for just 3pc? Idiot journalists who harp on about the Libor rate as if it is something 'made up' by the banks just demonstrate their ignorance. The banks are paying the government 12pc for tier one capital, tier one capital requirements were put up by around 40pc by the FSA, sources of funds want rates of 5pc plus.... This all adds up to less money being available at higher rates (spread over base rate).

The banks have a weak capital position, this will get better over time, but if the recipients of the Queens Shilling are forced into loss making lending by misguided politicians then the UK could have a real disaster on its hands. By 'real disaster' I mean the failure of one of the 'big four'.

Just because the central banks says "oh, base rates are now 3pc" does not mean that a fund manager will lend to a bank at that rate. In the era of easy money this was the case, but now? I think not. In fact, if rates go too low then cash becomes a pretty uninteresting asset class which could harm liquidity all over again!

This said 1.5pc off the base rate is obviously good news and has been called for by many (myself included) for many, many months. Eventually the lower rates will filter through as 'risk' liquidity returns. The reaction of the markets to the surprise cut was one of fear that the MPC (who have had their heads stuck in the sand for so long) knows something truly terrible to make such a radical change in direction. If this proves to be unfounded then the value of equities becomes much more obvious. Many companies with good dividend cover are paying well over 4pc... just hunt through the financial sections of the newspapers to find them. I would expect a return to the buy side today as funds are committed to the markets but we will need some further data before we can call a bottom.

The average UK citizen is in debt so lower rates should give more 'cash in pocket' the hope will be that this will offset the rising tide of unemployment enough to re-stimulate the economy. Of course lower rates in Europe can often be a twin edged sword. The average German is believed to actually have €140K in savings, lower rates here actually means less money for many and so might have a reverse effect on the high street!

BA has managed to confound analysts by reporting much higher Turnover than expected but in the same breathe reported a loss of £49m (£65m profit expected). Obviously the higher fuel costs were not being offset by the swinging surcharges that BA slapped on. With oil now down at around 60 bucks (I would recommend a bit of hedging at these levels) the cut in costs is running against the fall in current passenger numbers. Octobers Bums on Seats number was 4.4pc down on last year which is not exactly surprising but the reported loss can truly be said to be a sign of the past rather than any indication at all of the future. BA is likely to be a 'last man standing' airline so selling out at this stage would not appear to be on the cards.

The FTSE is being called some 30 points to the good at around 4300 having traded as low as 4150 last night. It is probably inadvisable to leap in with both feet just yet as the downturn will almost certainly have a few nasty surprises up its sleeve over the coming year but the actions of the MPC yesterday are at least an indication that the authorities in the UK are finally moving to a more aggressive tune.

The Tradefair Spread Betting Team