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Money Marketing Markets: ‘Rate cuts, Libor and teacakes’

Even the Bank of England’s Wednesday interest rate cut could not save the market from falling this week and its lack of impact is indicative of the problems in the banking sector.

Rate cuts are typically priced into the stockmarket well ahead of their announcement but the latest 25 basis point reduction was notable for having no impact on Libor.

“The market’s forward expectations are that interest rates will be at 4.6 per cent in 12 months time but the 12 month Libor rate is still up at 5.8 per cent,” says Gary Reynolds, chief investment officer at Courtiers Investment Services. “The expectation that rates will come down is just not being reflected.”

He says this will create winners and losers in the sector with those that need access to funding likely to struggle and those that don’t set to benefit from improved margins.

Chris Iggo, senior strategist at Axa Investment Management agrees. He says: “Something is wrong in the banking world. On Thursday, the Bank of England’s monetary policy committee announced a reduction the official bank rate to 5.0 per cent, a cut of 25bps and the third such move since November.

“However, on the same day, several leading mortgage providers announced that they were raising their fixed-rates on certain mortgage loans. While the bank rate is now at a 15-month low, interest rates on two year fixed rate mortgages are currently at their highest levels since the summer of 2000 when the bank rate was 6 per cent.”

HSBC is bucking the trend, offering a rate-matching deal to investors and this show of financial strength meant it was the only bank not to slump this week.

Barclays, HBOS, Royal Bank and Lloyds TSB were all down by between 7-9 per cent over the week by mid-afternoon Friday, while HSBC was actually up 2p to 852p.”

An IMF warning of a one in four chance of a recession and disappointing numbers from GE’s financial services division on Friday compounded concerns and the banks are set to lead the FTSE 100 down overall.
Evidence that consumers are starting to feel the pinch came on Thursday when DSG International, the owners of Curry’s and PC World issued its second profit warning in three months.

It said total profits are expected to come it at up to 20 per cent below its January prediction, sending its shares into an 8 per cent slide. Next, Marks & Spencer, Kingfisher and Home Retail Group were all dragged down by the news. Even victory in the battle of the teacakes has failed to revive M&S, which could be set for a £3.5m VAT rebate after European courts found the Government wrongly labelled its teacakes as biscuits. Apparently teacakes are VAT exempt but biscuits are not, inexplicably.

Reynolds believes the slowdown in consumer spending is inevitable and reflects the time-lag effect of previous rate increases.

“The DSG warning is no surprise because consumers will have to cut back this year. The Bank of England admits that when it raises rates it knows certain people and asset classes will be affected but it cannot predict who. Interest rate rises are like a financial chemotherapy,” he says.

Elsewhere, it was a positive week for the oil and mining majors with BP and Royal Dutch Shell enjoying strong demand on the back of racing oil prices.
Crude oil soared to $112 a barrel. Reynolds believes only speculation is underpinning the current price and he points to the 2006 Stern Report, which said all of the world’s oil can be extracted for $70 a barrel. Ongoing strength in commodity prices led Rio Tinto to a record high of 6,000p, while rumours of further Chinese stake-building also buoyed the sector.

Pharmaceutical giants Glaxosmithkline and AstraZeneca also tumbled this week. Glaxo was hit by news that US health watchdogs had criticised its reporting on data on its anti-diabetes pill Avandia, while Astra was held back by broker downgrades.

At the end of the week, with the blue chip index trading at 5,896.1, down a further 1.16 per cent, or 69 points, on the day, it is easy to forget that the market actually passed through the 6,000 barrier on Monday for the first time since February 27.

Monday was the only up, carrying on from last week’s strong run before the banks did their best to spoil the party.

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