Volume 04 (2009, Week 04)

Calls for higher oil prices
The oil cartel and big energy firms say $50 per barrel for oil is too cheap to fund future investments.

The oil price has been falling steadily since July 2008, when it peaked at all-time-high of $147 per barrel (even when adjusted for inflation). Now it stands just above $40 a barrel for relief of many.

Now, bosses of OPEC and big energy firms such as BP and Royal Dutch Shell are calling for higher oil prices. This call comes despite the record profit of $31.4bn made by Royal Dutch Shell and $40.6bn profit made by Exxon Mobile for the year 2008, each setting record not just for themselves but for European Corporate and USA Corporate history respectively.

Abdalla El Badri, the Secretary-General of OPEC, said "A $50 price will not allow us to invest. If we don't invest now, then we will store up a problem in three years from now when demand picks up." Tony Hayward, BP boss, thinks $60-80 a barrel would allow firms to invest in for further exploration as well as meeting OPEC demands, which supplies about 40% of the world demand.

OPEC says it will cut down production if price continues to fall, as it thinks there is excess supply of about 2 million barrels per day (bpd). It has already decided to cut down its production by 1.5 million bpd in its October meeting last year.

However, in less than just 5 years ago, in June 2004 when oil price reached $42.45, the record at the time, countries were asking for increase in oil production. So has the price of exploration for oil have increased by that much in just 5 years? Surely the oil giants have been making record profits for the last three or four years that they can use their piles of cash to invest in for further development. Or have they simply got so used to high oil prices and easy money (I mean profit by easy money and not credit, as it has been the case for consumers in the last decade)?

It is true that the current price levels make some projects unviable, for instance many of Canada's tar sand oil projects are being postponed as a result of cheap oil prices and credit crunch.

In my opinion, it is important that world becomes less relient on oil by becoming more energy-efficient and investing more in renewable energy, such as wind and solar power. Unless we do so, we will be just postponing inevitable problem. If oil-producers get to have their own way, the only winners will be them and we will still be facing higher energy prices in the future.


OIL PRICE: The last summer's oil price hikes cannot be blamed on producers alone. It is largely to be blamed on speculators, mainly from commodity hedge funds. According to OPEC and Saudi Arabia, the world's largest oil-producer, there was not a shortage of supply in oil. Indeed, Saudi Arabia was running spare capacity of 1mn bpd last year (equivalent to 1.2% of world demand).

Speculators remain silent in general, those few who respond to media claim that they are not responsible for those price hikes and falls. According to Sean Corrigon, an English fund manager (called Diapason Commodities Management) based in Switzerland, speculators trades in oil count to only 5% of the total trade and claims that it is too small to have that much impact on the oil price. However there are two problems with his argument. First, 5% is not that small, considering that oil is a price-inelastic commodity (meaning large changes in price lead to small changes in its quantity consumed and vice versa). Second, 5% is likely to be the average value, therefore there could be much higher proportion of trade made by speculators during these roller-coaster period for oil price.



Ailing British Car Industry
On Tuesday, 27 January, Business Secretary Lord Mandelson announced £2.3bn help to troubled UK auto-industry.

Lord Mandelson emphasises that this new announced package is not a bail-out. He made it quite clear last year, that the government is not going to help all the businesses seeking help from the government.

The package is basically loan guarantees for car-makers, which are finding it hard to raise capital just as any other businesses. It is largely aimed at developing more fuel-efficient cars. £400mn is believed to go to Jaguar-Land Rover, which is owned by Indian Tata group now. Jaguar-Land Rover has been asking for £900mn to finance working capital and to invest in low-carbon cars.

The UK car-industry employs around 850'000 people directly and indirectly, manufacturing some 1.65mn cars. About three-quartes of the cars are exported, mainly to Europe.

The opposition says the package is too small to prevent job losses, which kind of contradicts their policy, as they have been opposing excessive government spending. But they may be right, as Nissan has cut 1200 jobs in its Sunderland plant, Jaguar-Land Rover cut further 450 jobs and Honda is suspending its production for four months. Even luxury car-makers are cutting back, Aston Martin has announced loss of 600 jobs last December.

It is unclear how UK auto-industry will come out of this recession, which has been struggling for decades, now all major players owned by foreign companies.

Banks' shares up sharply

Barclays shares up by 73%
Barclays chairman Marcus Agius and chief executive John Varley sent a joint letter to investors

Barclays share eventually rose by 73% after the bank's chairman Marcus Agius and chief executive John Varley sent a joint letter to investors assuring that Barclays is set to make a profit despite £8bn write-downs by Barclays Capital, its investmenh banking arm. It fell for 9 consecutive-days till last Friday. Despite today's spectacular rise, it still remains well below its price level before its continued losses, in fact just about half the value, at 88.70p.

FTSE 100 closed 3.86% up. It was up by 4.2% at one point, which would have made it today's performance to the top 20 FTSE day-performance.

Other banks shares are up sharp as well, in particular RBS and Lloyds, which saw 20% and 32% rise in their shares respectively. Overall, it was a very good for the market after all the downwards pressure fore more than 2 weeks.

Volume 03 (2009, Week 03)

UK is officially in a recession
The official government figure shows UK economic output has fallen for two-consecutive-quarters.

It was widely anticipated that UK is gone into a recession in the second half of 2008, but figures are worse than expected. The UK economy shrank by 1.5% in the last quarter of 2008 after falling by 0.6% in the third quarter.


Source: BBC

The unemployment has reached 1.91 million in November 2008, the highest level since September 1997. Since then, many more thousands of jobs have been lost. It looks like, everything done by Labour government since 1997 is being undone in the last year or two after Gordon Brown's claimed "golden age".

The industrial output is awful, it shrank by 4.6%, the biggest contributor. But as seen from the graph below, it is not as bad as other big economies.


Source: The Economist, January 17th-23rd, 2009

Well known investor, co-founder of Quantum Fund, Jim Rogers basically said "The UK is finished" after the government's plan for second-bail-out for the banks anncounced on Monday. “I would urge you to sell any sterling you might have. It’s finished. I hate to say it, but I would not put any money in the UK” is what he said. The bail-out of the banks are making the public debt to new high-levels.

Dr Andrew Lilico, the Managing Director of Europe Economics, predicts the recovery would not come until 2011. He sees a possible growth for a single quarter in 2010, as a consequence of all the monetary and fiscal measures taken in the last 3 months as it takes 18 months for those policies to have a full impact on the economy. But he doesn't see a full-year-recovery anytime before 2011.

The economic situation is certainly worse than many people expected and it seems it is going to be a long recession. The UK and the USA are worst hit amongst the industrialised economies. In my opinion, the economic growth seen in the last decade was largely due to consumption-boom, which is unsustainable. These consumption-boom was made available thanks to the cheap-credit, largely coming from Asian economies, such as Japan and China.

It is true that, those who were financially prudent are being hurt as well, for instance Germany and South Korea. But those countries are far better placed, when the global economy turns around and I am sure they will come out even stronger than they were before the global slowdown. People in the UK and the USA have to start saving, if they are not to repeat what has happened. The boom in the 1920s, which lead to the great depression of 1929-1933 in the USA was largely due to cheap credit and excessive spending. The history is repeating itself.

Pound Sterling continues to slide down
This week, the pound sterling has hit all-time-low against yen, 24-year low against dollar.

As UK economy slides into a recession officially, pound hits new lows against major currencies and FTSE is gone below 4000 level once again since December 2nd, 2008.

Jim Rogers predicts that pound will break its all-time-low record against the US dollar (£1=$1.0520 in Februart 1985). Some experts believe triple-parities may be possible in the near future: £1=$1=€1.

It is hitting UK travellers hard, many deciding not to have holidays abroad or those who already studying or working abroad deciding to come back.

But of course, it should be helping the UK exporters. Despite ever-shrinking manufacturing sector of the UK economy, UK still remains one of the top 10 exporters in the world, exporting goods worth £220bn. However, UK is a net-importer, meaning it buys more goods than it sells in terms of valuation. Therefore, British consumers may find themselves facing higher prices on imported goods, in particular electronic goods and clothing.

As a result of falling pound, the UK is now the sixth largest economy in the world. It once ranked as the fourth largest, before China overtook it. Recently it has been taken over by France and it could be overtaken by Italy if pound continues to depreciate against euro.

Can Banks be rescued?

Banks' shares in a freefall
The government's plan to help banks sent banks' shares down by historic amount

Today was a day, which made records, but not pleasant ones. It made Friday's freefall of banks' shares to look like as if they were floating.

Royal Bank of Scotland (RBS) was the biggest loser today not just within the banking sector, but in whole FTSE 250. Its share price plunged by more than 66%!!! Bringing down its price level to the lowest ever of just 11.6p, making its market capitalisation to under £5bn! It was a company, which took over then Netherland's biggest bank, ABN Amro for a massive €71bn (just under £50bn at the exchange rate at the time of merger) in less than two years ago, October 2007.

In fact, its acquisition of ABN Amro is a huge source of its troubles, as it bought during the peak of stock market. Today, it faces £20bn of loss related to its acquisition of the Dutch Bank in addition to its write-downs of between £7bn and £8bn. It means it is to set a record in British Corporate History: the biggest loss ever. This potential total loss of £28bn is almost the double of the current record of £15bn held by Vodafone in 2006.

The government is also changing its preferance shares (with no voting rights, but with fixed percentage interest rate before anyone else gets paid) to ordinary shares (with voting rights, but with variable divident). It will bring the government's stake in the bank from 58% to 70%, and this time with voting rights! So there is no wonder, why investors dumped its stocks non-stop today. Its trading volume reached to a massive 744 million shares, the highest level ever seen as far as my data goes (the first available data being January 1st, 2003). I am sure the lift of ban on short-selling on last Friday helped it too. The ban was initially introduced by the Financial Services Authority (FSA), the UK watchdog of financial institutions, in September 18th, 2008 after a heavy loss of banks' shares. The next day, on Friday of September 19th, FTSE saw its biggest ever daily-gain in percentage term at the time of 8.8% (it was broken in November 28th, 2008, 9.84% rise).

Lloyds Banking Group saw its share price plunge by more than 33% on its first trading day. Lloyds Banking Group is the new bank, as a result of the merger between Lloyds TSB and HBOS. It is now the biggest high street bank in the UK with more than 3000 branches across the country. The UK governments has a stake of just over 43% in the new "super-bank".

Standard Charteded's share price dropped by 12.1%. Barclays share price slides down for the 5th day-in-a-row after gains of 8 consecutive-days. In percentage terms, it is down by more than 52% than last Tuesday, just before it started falling and still down by over 40% than its magnificient continuous rise of 8 days. HSBC, another bank refusing a state help, saw its shares down by 6.5% amid the rumour of it is running out of cash, and soon need to be rescued, although HSBC has not announced anything officially.

All of these huge drops come just after the second bail-out plans (worth £100bn) set by Mr Gordon Brown, the UK Prime Minister over the weekend while he was in Middle East on the talks of Gaza ceasefire-plan.

Today was the day, that British Bankings System came close a collapse once again after a turmoil in September and October. Some of the biggest names in the sector, HBOS and RBS came dangerously close to collapse in October before the first bail-out of £37bn by the UK government. Yet, most of us started believing that the banks are so huge now, that it is impossible for them to collapse till September 2007, when Northern Rock collapsed. It was the biggest bank to fail for 12 years, after Barings collapsed in 1995 due to massive loss of £800mn made by Nick Leeson, a rogue trader.

One then asks, how come the banks are so fragile? After all, they have been making record profits of billions of pounds, or even tens of billions of pounds just 2, 3 years ago. Where did all these profits go?

The banks are so vital to the functionality of the UK economy as a whole, that the government is determined not to let any of the big banks to fail. However, it seems, the damage is already done, the confidence in the banks are gone. At the same time, banks' confidence in the economy is gone, as a result they are so reluctant to lend money to even sound businesses. The government has been trying hard to revive those confidences ever since it nationalised Northern Rock in September 2007, but it seems its efforts to help the situation are sending "the economy is in trouble" and "the banks are in trouble" signals, just the opposite of what they want.

The government's fiscal effort has not been much better. Its cut of 2.5 percentage point in VAT for 13 months was a joke, more or less waste of money (gone tax revenue of £12.5bn), resource (physical and human costs related to the change of VAT) and time (all the time spent on changing VATs and recalculating). The monetary decision made by Bank of England, doesn't help the banks either. The low interest is just squeezing the margin for the banks and make it more difficult to make money and pay their debts for the banks.

This economic downturn might be worse than any of us imagined before. The results from the last quarter of 2008 are horrifying and far worse than many experts expected. The industrial output is down in both developed and developing economies by a huge amount, for example Taiwan's fell by more than 45% in the three months up to November 2008 compared to previous three months at annualised rate and South Korea's fell by 25%. The exports and imports in most countries are falling sharply, demands for many goods and services are collapsing around the world, with the exception of food and health care. Now deflation in rich economies are real and possible threat in 2009. The housing market is in a freefall, the average UK house price was down by 15.9% in 2008.

If any of the big banks fail in this time, the recession will be prolonged and even more severe. So the governments will try everything they can, in order to rescue the banks.

UPDATE (on 20th January 2009):
This morning FTSE and banks' shares saw a steep jump (but nowhere steep enough to compensate yesterday's loss) despite heavy losses in Asian markets (over 2% drops) and Asian banks' shares. However shares started falling again, hitting the bottom around 12PM and saw slight rise afterwards. From 3PM onwards, shares started sliding again, all banks' shares closing lower than yesterday's closing once again.

Here is the summary of day-performance:
FTSE down by 0.42%, closing at 4091.40
HSBC down by 3.19%, closing at 485.00p
RBS down by 11.21%, closing at 10.30
Lloyds down by 31.08%, closing at 44.80p
Standard Chartered down by 2.34%, closing at 689.50p
Barclays down by 17.16%, closing at 72.90p

Banks' shares in a freefall

Banks' shares down as much as by 24% amid the fresh fear of huge losses by banks

FTSE 100 was down by almost 5% this Wednesday after 5 consecutive-days-loss. The banking sector was among the worst performers on that day. The loss for all the banks, but Standard Chartered, continued.

Asian markets were up on average about the time trading time started in London Stock Exchange (LSE). This morning, there were slight rises in the banks' shares and we saw pretty much flat price-level until 3:45PM. Then, there was an announcement that the chairman of Royal Bank of Scotland (RBS), Sir Tom McKillop is to be replaced by Sir Philip Hampton, the chairman of Sainsbury's. Then shares of all banks plunged.

For some peculiar reason, Barclays' shares were hit hardest, falling by more than 24% to its lowest level for at least 6 years, 98p bringing its market capitalisation to only £9.1bn. This is the bank that was seeking to take-over ABN Amro, then Netherland's biggest bank for £46bn and this is the bank that made more than £7bn pre-tax-profit for both 2006 and 2007. This means Barclays' shares are down by almost 47% in the last 4 trading days.

RBS' shares were hit second hardest, down by 14.8%, again to a historical low level of 34.7p. Lloyds TSB saw 7.1% drop in its share values, again 4th-day-loss in a row as the shares of RBS and Barclays. HSBC (Hong Kong and Shanghai Banking Corporation), once the biggest bank in the world in terms of market capitalisation, saw slightly milder drop in its shares, however its share price stands at historic low level of 535.75p.

The only bank, which didn't see fall in its shares in LSE, was Standard Chartered, although its share price still dropped in the last 45 minutes of trading and ended 0.85% up from its Thursday closing price.

It is not very clear what exactly caused these sudden plunges in all banking shares today. Of course, today was the day when the ban on short-selling was lifted, which would have created more dumpings of the shares than otherwise.

Today we also heard very gloomy news from US Banks, in particular Citigroup, was-the-largest-bank-in-the-world. Citigroup reported its loss for 5th quarter-in-a-row, bringing its total loss for 2008 to staggering $18.7bn. As a result, it decided to restructure itself and to split into two: Citicorp and Citi Holdings. Meanwhile, its rival and peer Bank of America is to get a fresh bail-out of $20bn from the US government and further $118bn worth of guarantees against its toxic assets.




UPDATE (on 19th January 2009):
Today's plunges in the shares of banks dwarfed Friday's fall. RBS saw massive 66.6% drop in its shares, meanwhile Lloyds Banking group saw 33.9% drop in its share price on its first trading day, after the merger of Lloyds TSB Group and HBOS. This time around, Standard Chartered didn't escape the fate of its rivals.

Royal Bank of Scotland (RBS) announced that it is expected to report a loss of between £7bn and £8bn, excluding the costs related to the takeover of ABN Amro in 2007. The total cost could reach £28bn, making it the biggest loss in the history of British Corporation and this will be almost double the current record of £15bn made by Vodafone in 2006. As a result, the shares of RBS, plunged by more than two-thirds, bringing its shares down to around only 11.6p (it reached only 10p around half past two). It was trading at aroud 50p only 6 days ago (or only 4 trading days), that's around 80% loss in less than a week. The current level of its share stands at only 1.4% (yes, only 1.4%!!!) of its peak in less than two years ago: 724p on February 20th, 2007. Even, as late as early September 2008, its shares were being traded at above 240p.

Another big loser was, not-so-old, but the new banking group, Lloyds Banking Group. It saw more than a third fall in its share price, bringing its share price down to only 65p. At one time, it was down to 60p.

HSBC, Barclays and Standard Chartered saw 6.5%, 10.2% and 8.1% falls respectively in their shares.

Volume 02 (2009, Week 02)

Heathrow Third Runway
The Labour government has approved plans to build a third runway for London Heathrow Airport.

On this Thursday (15th of January, 2009), Geof Hoon, the Transport Secretary, announced that the government has approved plans to build a third runway for the-most-hated major international Airport, London Heathrow.

London Heathrow is operating very close to its full capacity (99% of the full capacity according to Geof Hoon). Even though it is the third busiest airport in the world in terms of passenger numbers (behind Atlanta's Hartsfield-Jackson and Chicago's O'Hare), it has got only two runways, while its much smaller rival European airports have got more runways, hence more capacity and making the journey more pleasant. For example, Frankfurt International Airport has got 3 runways and its plan to build 4th runway is already approved and expected to be in operation in as early as 2010. Amsterdam's Schiphol has got 5 runways and it is the-most-favourite airport in Europe according to Skytrax. Frankfurt handles about 80% of the passengerts that London Heathrow handles and Schiphol handles about 70% of what London Heathrow handles.

Even though, the plan to build Heathrow's third runway has been approved by the government it has a long way to go. The Conservatives promise that if they are elected in the next general election, they'll scrap the plan. The planning is expected to take years, and construction of the third runway is not expected to start till 2015, giving a plenty of chance for Conservatives to scrap the plan, as at least two general elections will be held till then. Also, there will be a lot of resistance from the environmentalist and residents in the area, where the third runway will be built, as 700 houses need to be demolished. The government had already seen some serious protests from the campaigners.

However, people in business and financial sectors welcome the plan and says it is "necessary" that Heathrow expands in order keep London competitive place for businesses and financial institutions. They fear that transatlantic traffic will be diverted to other European cities, such as Frankfurt and Amsterdam from London, if Heathrow fails to increase its capacity and improve its services.

In my opinion, the third runway has to be built for the sake of UK economy. In a way, it is like some of the economic concepts that are quite difficult to explain it to the public, like free trade and spending more in a recession. Of course these concepts are absurd for any individual unless they see a bigger picture. It is very tempting to ask for more protection for domestic manufacturers from foreign competitors in this difficult time, but governments know that if they increase tarrifs on imported goods, then everyone will be worse-off and certainly most economic advisers will remember the disastrous Smoot-Hawley Tariff Act of 1930. Similarly, it sounds unreasonable for governments to ask people spend more when people are facing potential salary-cut or even worse, redundancy in the near future. But, of course the governments know that if people start spending less and less, then economic situation will deteriorate even further.

I think it is similar story for the expansion of London Heathrow, the very gateway for London, even though London has 4 other major international airports (Gatwick, Stansted, City and Luton). Most of the routes to North America Asia are handled by London Heathrow.

People talk about air-pollution, noise-pollution etc. But I think actually having more capacity will make air-pollution per aircraft lower, not taking newer and more-efficient aircrafts into account. More capacity means that aircrafts don't have to be circling around the airport for nothing other than waiting, as much as now. Therefore there will be fewer airplanes in London air, probably even reducing the total air and noise-pollution despite an increase in the air-traffic. But that will depend on the-much-doubted efficiency of the airport itself.

Another big loss for FTSE 100

One of the worst FTSE 100 performance day
Today's loss brings down FTSE to its early December 2008 level

Today, FTSE 100 closed 4.97% down from the previous day's closing to 4180.64, its 17th worst ever daily performance in percentage terms.

Today, most of the Asian markets closed up from yesterday's closing, with the exception of few, for example Indonesia's Jakarta Composite (down 0.93%). Even though Hang Seng closed up 0.24%, in the last half-an-hour of trading time, it lost 2.30 percentage point, losing almost all of its gain during the day. Similar stories are told for the Asian stock markets which were open after GMT 7:00 A.M.

The recent economic and financial stories have been very gloomy and indeed. Yesterday, the Office for National Statistics (ONS) announced that UK trade-deficit has hit a record level of £8.33bn in December, while The British Chambers of Commerce (BCC) and The British Retail Consortium (BRC) gave a "frightening" picture for UK Retailers. Barclays announced job-loss of 2100 as well. Today's news were not much better, Jaguar Land Rover announced it is cutting 450 jobs, while Zavvi closed down further 18 stores reducing its workforce by 353 addition to its decision to close 22 stores and to cut 178 jobs on last Thursday.

"17th worst day performance ever" may sound not so scary. But if you look at the list: the second one is the Black Monday (October 19th, 1987), and 1st, 6th and 9th places are taken by dates within a week after Black Monday. Six further dates are in October 2008, one each in late September 2008, November 2008 and December 2008. There is also September 11, 2001. It seems October is the worst month of the year for stock markets, with 10 out of 16 worst performance in October (while all, but one, are in the second-half of the year and all, but two, are in the last-quarter of the year).

It was not just the average of the components did badly today. If one looks at FTSE 100 components, then 4 out 102 shares are all down, that's pretty awful performance by anyone's standard. FTSE 250 did much better than FTSE 100, even though it was still down 2.81%. Indeed, today's most of the winners in London Stock Exchange come from FTSE 250 Composite and not FTSE 100.

Banking sector was hurt badly, with all shares down by 2 figures, except HSBC shares, which managed to climb up by 18p (2.81%) in the last 20 minutes of the trading day (it literally climbed up 8pence in the last minute). Barclays had another heavy loss today, 14.35%. Yesterday it lost 10.13%. Its share was doing remarkably well prior to its announcement of 2100 job-loss yesterday, having at least 8 consecutive trading-days rise. However all these gains have been lost and is even lower than the level before all these wonderful continuous gains.

Today was the last trading-day for shares of HBOS, which is being merged to Lloyds TSB on this Friday. Unfortunately it was not the best day of HBOS shares, standing at mere 6% of its value of January 2007 and only one tenth of its February 2008 level. It will be exchanged for 0.605 Lloyds TSB shares at the closing of tomorrow's business today. Once, its shares had been offered for 0.83 Lloyds TSB shares, however further problems with HBOS forced the exchange-offer to be revised down.

Today's big loss brings down the FTSE level to its early December 2008 level. Since December 5th, 2008 it has been rising slowly but steadily till Wednesday last week. The loss from the last week wipes out all the gains which has been made over a month-period. American markets opened around 3% down today.

The fall is likely to continue further, with the possibility of bringing down FTSE 100 under 4000 once again, the level which was seen on November 24th, 2008 last time.
(see UPDATEs for future movements)

			Date	Close		Day Change	Percentage Day Change
			Biggest declines in percentage terms, based on closing values The FTSE 100 started in 1984 at 1000 The list source: guardian.co.uk
			October 20 1987	1801.60		-250.7	-12.22%
			October 19 1987	2052.30		-249.6	-10.84%
			October 10 2008	3932.10		-381.7	-8.85%
			October 6 2008	4589.20		-391.1	-7.85%
			October 15 2008	4079.50		-314.7	-7.16%
			October 26 1987	1684.10		-111.1	-6.19%
			September 11 2001	4745.98		-287.7	-5.72%
			November 6 2008	4272.41		-258	-5.70%
			October 22 1987	1833.20		-110.6	-5.69%
			January 21 2008	5578.20		-323.5	-5.48%
			July 15 2002	3994.50		-229.61	-5.44%
			October 16 2008	3861.40		-218.2	-5.35%
			September 29 2008	4818.77		-269.7	-5.30%
			December 1 2008	4065.49		-222.52	-5.19%
			October 8 2008	4366.69		-238.52	-5.18%
			October 24 2008 January 14 2009	3883.36 4180.64		-204.47 -218.51	-5.00% -4.97%

UPDATE (on 15th January 2009):
Today, FTSE 100 closed 1.42% down, at one point it was down 2.14% touching today's lowest level: 4090.87.

UPDATE (on 19th January 2009):
After a rise of 0.63% on Friday, it saw 0.93% drop today, regardless of rising by more than 2.5% in the early morning. At one point, it reach 4032.40, getting closer to the benchmark of 4000.

UPDATE (on 23rd January 2009):
Today, FTSE is gone below the benchmark of 4000 after its continuous fall since January 7th, (with only 0.63% rise on January 16th). On Wednesday it came very close to reaching 4000, hitting 4001.40.

Volume 01 (2009, Week 01)

Interest Rate hits all-time low
Bank of England cuts interest rate (again).

On this Thursday (8th of January, 2009), Bank of England (BoE) announced a further interest cut of 0.5%, bringing down the base-rate to 1.5%, the lowest level for its entire history of 315 years. The cut was widely anticipated.

Bank of England (BoE) has been cutting the interest rate aggresively (maybe little bit too aggresively) since 8th of October, 2008 amid the fear of economic recession in the UK. In early October, the interest rate stood at 5.0%, but it has been cut by 0.5, 1.5 and 1 percentage points in October, November and December respectively.

There are two main motivations behind all these bold interest-rate cuts: (1) to increase the spending of individuals and (2) to make credit more affordable to the businesses; both in order to boost the economy, or rather to make the recession milder in this case. The technical term for this kind of action is known as expansionary or loosening monetary policy.

The expansionary monetary policy works like this: it seeks to increase the total money supply in the economy, therefore increasing the money circulation which leads to increased economic activities and increases the economic output (or consumption). At least, that's the theory. In most countries, Central Banks have the responsibility for the monetary policy (BoE and its Monetary Policy Committee (MPC), which consists of 9 people, are responsible for the UK monetary policy).

Enough about the background and boring stuff, and to the big question: "Is it working?". In ordinary situations, let's say 2 years ago, such a policy would have had a large impact on the economy and probably would have driven the inflation far too high. But so far, the impact in the last 2 months have been very little, if there has been any impact in the first place.

Of course, the are beneficiaries from these interest-rate cuts: borrowers - people who have got mortgages, and any other type of loans as well as businesses, most of which are in operation thanks to credit. However, not everyone has got a tracker mortgage, meaning there will be many people who simply would not benefit from the cut. In fact, the majority of the mortgages in the UK are on fixed-rate. Also, not all the banking and lending institutions are going to pass on the full interest-rate cuts (that is total of 3.5 percentage point cut since October last year) to those who are on variable-rate, simply because some of them cannot afford to cut it.
It is unlikely that consumers are going to spend everything they have gained from these gains due to lower payments on their mortgages and loans, which means the expansionary policy could fall short of what it tried to achieve.
According to Paul Lewis, the presenter of BBC4 Money Box, there are already 88 savings accounts offering 0.5% interest rate or lower (see UPDATE). Surely, the full interest-rate cut can not be applied to those savings accounts. This will squeeze the profit margins of already struggling banks and other lending institutions.

In my opinion, whatever result comes out of all these cuts in the short-term, the long-term effect is going to be disastrous. The are 2 main problems:
First, it is penalising the savers, who have been prudent in the over-spending and over-borrowing period. It is the savers, who can potentially save the economy as they provide the very money available for businesses and individuals to borrow. The low interest-rate will discourage the savers and if this low level of interest rate is sustained for long-period, it can be fatal for the UK economy, as the already low level of savings-rate can go down even further, making another credit-crunch in the future very possible.
One group of losers is going to be pensioners, who supplement their pitiful state-pensions with the interest-rates earned from their life-long savings. They may well be forced to start withdrawing larger amounts of money from their savings as their income on the interest-rates dwindle.
Second, we are in credit-crunch! For the past 18 months, we have been talking about credit-crunch, and there is not enough credit out there. The only thing interest-cut does to credit is, it makes the credit cheaper, and it is not increasing the availability of credit. There is not much of a point trying to make something cheaper, which doesn't exist!

From a different perspective, the pound-sterling has been depreciating against the euro and US dollar dramatically. This helps the British firms, as it makes the British exports cheaper abroad, hence more attractive and given that the USA and Eurozone countries make almost four fifth of the UK international trade. The fall in the value of pound can partially be attributed to aggressive interest-cuts of BoE, while European Central Bank (ECB) has been much slower in cutting its base-rate, now standing at 2.5%, although it is expected that it will be cut further next week (see second UPDATE). This means, the interest-rate cut may be helping the UK economy from a very different angle than the BoE intended to.
However, we don't know how much impact the interest-rate had on the exchange-rate. Indeed, the pound has started falling sharply agains the US dollar from August 2008, well before the interest-rate cuts started. Also it has been falling against the euro ever since the introduction of euro in 1999, although recent fall has been far sharper, that it could be called currency-crisis as it has tumbled by more than 20% within 2 months up to 29th of December 2008, where it hit all-time low of only €1.0198. So given the time frame of this sharp fall against the euro and slow interest cuts from ECB, the impact of interest-rate cut from BoE on the exchange rate could well be significant.

As far as winners and losers are concerned from these interest-rate cuts, the losers will be more than the winners, at least in the long-term. The positive significance of this week's cut is probably only historic.


Related articles:
Interest Rates Hit All-Time Low, BBC News | Business
Combating the Recession, Economist | Britain
Does the Bank Rate Matter? (Rober Peston)

UPDATE (on 12th January 2009):
According to Moneyfacts, 60 instant access accounts - 17% of the total - pay just 0.3% or less on sums up to £5,000. Of those, there are three banks or building societies that pay nothing at all on some of their accounts, one that pays 0.001% and six that pay just 0.05%.
(Full article)

UPDATE (on 15th January 2009):
As expected, European Central Bank (ECB) has cut its interest-rate to 2%.