Weekly international investment round up to 28 October 2008
Today the US Federal Reserve will announce their decision on reducing interest rates. In an attempt to throw everything it has at the financial crisis the reduction in interest rates is the fed’s final ‘kitchen sink’ having overseen previous bailout plans and fiscal stimulus packages and amazingly, reducing rates to zero is on the cards.
US interest rates were cut by a half-percentage point earlier this month following an emergency meeting with rates now standing at 1.50 per cent. If the scale of the crisis in America was ever in doubt the fact that the Fed could actually consider reducing interest rates to nothing in one fell swoop says it all but in reality a further reduction of another half-percentage point is likely today as the Fed will probably want to conserve some of its ammunition.
The Japanese style ZIRP (zero interest rate policy) which was used by the Bank of Japan for much of the 1990s is seen as a very aggressive approach which is usually taken in order to stimulate an economy when all else has failed similar to how a doctor would use an electronic defibrillator to stimulate a patient’s unresponsive heart. Apart from using up the all the Fed’s remaining ammo this method could also be seen as being too deflationary and although the move towards zero hour will be tempting this final weapon is likely to remain in the Federal Reserve’s holster for the time being.
Today’s announcement by the Fed may grab the headlines but over recent days interest rates have been yo-yoing around the world. However, the last time rates were at 1% in America was between June 2003 and June 2004 and while lower rates are obviously good news for consumers and businesses as this stimulates credit and encourages spending, some would argue this is the very thing that led America into the mess it now finds itself!
Lower interest rates can also help with another big problem, getting the banks to lend to each other. Over the last few days the London interbank offered rate, or LIBOR, which is the rate banks charge each other for three month loans fell to 3.51 per cent, according to the British Bankers Association. This is good news, as following substantial European and US Government baking for their banks in recent weeks banks still remain reluctant to deal with each other.
There are two possible explanations. First, banks want to hold on to cash rather than lend it out as their balance sheets absorb losses on bonds in failed or failing banks or on credit default swaps in which they were in effect insuring someone else against a default on these bonds.
The second explanation is that banks are holding cash in order to make their balance sheets look good for the 31 December accounting year end. But until banks lend to each other credit markets will remain blocked and a sustained recovery in the real economy is unlikely.
Not only is the clock counting down to the election of the next US President but could zero hour be approaching for US interest rates?
Mark Lamb is Director of FPC Investment Consultants who are Independent Financial Advisers and regulated by the MFSA to provide investment services under the investment services act 1994. For further details please contact Mark Lamb, by email on [email protected] by phone on 21318008 or through FPC’s website www.fpcmalta.com
This article does not intend to give investment advice and its contents should not be construed as such. Information in this article has been obtained from various public sources and is given by way of information only. Readers are always encouraged to seek independent financial advice before making any investment decision.
