UK Interest Rates Have Peaked

Over 250,000 British people buy a second home abroad every year. Jon Beddell from foreign exchange broker TorFX discusses the impact of the recent financial market turmoil, and the next move for Sterling.

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We are seeing record trading volumes in the Australasian currencies. Clients are increasingly using forward contracts* to lock in favorable exchange rates, taking advantage of the current volatility. Conversely, clients buying in Europe are also booking forward, but for the opposite reason. They see the weakness in the exchange rate, and would rather fix their rate than face further losses.

(PRWEB) September 17, 2007

Over 250,000 British people buy a second home abroad every year. Jon Beddell from foreign exchange broker TorFX discusses the impact of the recent financial market turmoil, and the next move for Sterling.

Just a few weeks ago most economists were expecting the Bank of England to raise borrowing costs to 6% at the September meeting. Stock markets were strong, inflation risks were still deemed to outweigh growth concerns, the housing market was firm and credit was still easily accessible. Unsurprisingly with this backdrop, sterling was enjoying a strong run against most major currencies, hitting 2.06+ against the US dollar, and 1.4950 against the Euro. Fast forward six weeks, and things look very different. It is now widely accepted that interest rates have peaked at 5.75% in the UK, while in Europe further rate increases are still on the cards. British homeowners previously worried about rising mortgage costs will be breathing a sigh of relief, but for anyone looking to buy a home abroad, particularly in Europe, the changing interest rate outlook is already having a serious impact on the cost of their purchase.

Previous expectations of a rate hike to 6% gave sterling a 2% yield advantage over the Euro (which yields 4%), helping the pound tread water through the summer months. The recent financial market turmoil triggered by the US sub prime mortgage crisis sent ripples through the world's financial markets, prompting central banks to take drastic action by providing cheaper credit to the banking system in order to avert a credit crunch. The Bank of England is the only major central bank not to take action in this way, reluctant to contribute to what it sees as a "moral hazard". "If you protect someone too well against an unwanted outcome, that person (or bank) may behave even more recklessly".

Clearly not prepared to bail out the banks, the BoE are not so reticent when it comes to the consumer. The danger posed by a consumer led downturn now outweighs inflationary risks for the first time in nearly two years, making further rate increases very unlikely. The market has been adjusting to the new scenario over the last few days, leading to a steep fall in the sterling/euro rate. Notably, sterling fell below long term trend support last week, leading to warnings of further downside from technical analysts at TorFX, who follow price trends in the hope of predicting future direction. In a special market update on Wednesday morning (12th), clients were alerted to the "precarious" technical outlook. By the end of the day, the pound had lost nearly 2% on the week, which translates into an extra £3,500 on the cost of a European property priced at €250,000. Sterling suffered even larger falls against other European currencies this week, down over 3% against the Polish Zloty and Swedish Krona. However, buyers of the Australian and New Zealand currencies have seen exchange rates rocket by over 10% in the last few weeks as investors dumped high yielding currencies which are perceived as risky in the current climate. That is resulting in massive savings for anyone buying property in these territories.

"We are seeing record trading volumes in the Australasian currencies. Clients are increasingly using forward contracts* to lock in favorable exchange rates, taking advantage of the current volatility. Conversely, clients buying in Europe are also booking forward, but for the opposite reason. They see the weakness in the exchange rate, and would rather fix their rate than face further losses." said Jon Beddell of TorFX.

*( a forward contract allow the buyer to reserve currency at today's exchange rate for up to one year ahead, with only a small deposit required, removing the risk of exchange rate movements from their transaction)

In his first public comments since the credit crisis emerged, Bank of England governor Mervyn King yesterday recognized the potential impact on the consumer if banks start to pass on the higher borrowing costs they now face in the interbank loans market. The LIBOR rate (the rate at which banks can borrow from one another) has risen sharply above the Bank's base rate, and in the absence of cheap loans from the BoE, these costs will eventually be paid by the consumer in the form of higher mortgage payments.

Of course, what most foreign property buyers want to know, is where the pound will go next. If history is anything to go by, markets tend to swing far beyond expectations. The pound hit 1.5300 in January, seeming to defy even the most bullish expectations as the Bank of England surprised the market with an unexpected rate hike.

Considering the shaky outlook for stock markets, recent figures showing a sharp decline in inflation, an apparent slowdown in house price growth, and a dip in consumer confidence, the argument for a rate cut cannot be far away. Current market expectations are for a 10% chance of an October rate hike, and 0% chance of a cut. Given how quickly the outlook has changed in the last few weeks, it is entirely likely that by November, the debate for a cut in interest rates will be "in the market", which could send sterling sharply lower unless the ECB also ease borrowing costs. If the market overshoot mirrors the move we saw in January, that would imply an exchange rate of 1.4250.

About TorFX:
http://www.torfx.com
Tel: 01736 752142

TorFX is a leading provider of foreign exchange services, offering ultra competitive exchange rates for foreign currency transfers and an unrivalled personal service to private individuals and companies. TorFX is regulated by HM Revenue & Customs, and is also a member of the UK Money Transmitters Association.

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