FTAdviser.com

• Reports
• Fund Focus
• Sector Poll
• Sector News
• About Us
• Contact Us
• Literature

February 2008 - Can interest rate cuts revive world markets?

The first month of 2008 has seen investors hopefully looking for clues that the oncoming year will bear little resemblance to the uncertainty and unpredictability of the 12 months that preceded it. While fears of a recession in the US and concerns over the property market in the UK remain, January has seen a welcome element of calm restored to markets, mainly driven by the willingness of central banks to take decisive action. As Percival Stanion comments in the Barings Monthly Asset Allocation Views, the Federal Reserve's recent decision to cut short-term interest rates by 0.75 per cent shows that the US now has a central bank "fully committed to doing everything possible to maintain growth". So what exact effect has the recent spate of rate cuts had on the outlook for 2008, and will policymakers continue to push the cost of borrowing down to stimulate growth as the year goes on?

The Barings Global Weekly Review turns its attention to last week's interest rate reduction by the Bank of England, with the monetary policy committee (MPC) electing to cut the base rate from 5.5 per cent to 5.25 per cent. This move was widely expected of course, with most analysts predicting that the MPC will continue to lower rates gradually throughout the year.

Perhaps more pressing is the issue of interest rates in euroland. While the European Central Bank (ECB) opted to maintain its key rate at four per cent recently, there are signs that ECB president Jean-Claude Trichet has become "a lot less hawkish" about inflation in the eurozone and is "softening his hardline stance on a rate move", the Barings review suggests. The recent emergence of "gloomier" economic data for euroland means that Mr Trichet could sanction a rate cut sooner than expected.

This view is shared by Percival Stanion, who notes that the ECB's "complacency over the resilience of the economy" is beginning to falter as growth subsides and consumer sentiment softens. He is in agreement that European policymakers may be forced to follow the example of the UK and US by cutting interest rates, but is slightly more conservative with the timescale, stating that a reduction is unlikely to occur before the second half of the year.

Such a move is also hinted at in the Standard Life Investments Global Review, where Andrew Milligan notes that on both sides of the Atlantic "the authorities are beginning to realise the gravity of the situation facing financial markets and respond accordingly". He discusses the recent "high-profile action" in the UK and US central banks which has seen significant rate cuts beginning to restore market activity and the confidence of investors.

Crucially, Mr Milligan stresses that much work remains to be done, with the subprime fallout continuing in the form of the US housing recession, which he suggests "could last into 2009".

David Shairp shifts the focus back to euroland in his JPMorgan Weekly Stock Market Report for February 11th. He describes the ECB as being "on the path to Damascus" regarding its interest rate policy, as "the prospect of a really unpleasant slowdown" in European markets becomes increasingly likely and forces policymakers to rethink their position on rates.

While much investment attention remains focused on the UK and US markets, Mr Shairp suggests that analysts could benefit from monitoring events in Europe more closely, because the market currently represents "the Maginot line for the 'de-coupling brigade' who believe that a global slowdown can be avoided despite rising evidence of a US recession".

Tom Elliot also considers the interest rate question in the JPMorgan Monthly Investment Outlook, although he is less concerned with the future and turns his attention to immediate market concerns. Despite the MPC's recent 25 basis point cut and suggestions that the ECB is reconsidering its stance on interest rates, he states that "both European banks are running overly tight monetary policies" in light of current market conditions.

Describing the UK as the global economy "most in need of monetary relief", Mr Elliot speculates that this month's rate reduction from the Bank of England could be "too little too late" as property prices continue to fall and consumer confidence remains low.

Looking at the economy more generally, Julian Chillingworth takes an optimistic approach while continuing to advocate caution in the Rathbones Economic and Market Review, stating that 2008 is likely to be a year "of two distinct halves", with investment opportunities remaining limited during the first six months before a period of recovery begins in the second half of the year.

However, the Standard Life Investments Report suggests that such a defensive outlook in the early stages of the year may be misplaced, as the anticipation of further interest rate cuts stimulates activity and produces some good investment opportunities.

David Cumming, head of UK equities at Standard Life, states that "sentiment is too pessimistic and much of the negative news is already in the market". With this in mind, he highlights the current potential for investment in oil stocks, confident that the market's "sound management and strong competitive positioning" can yield positive long-term results for brave investors.

Nevertheless, investment strategies characterised by caution and defence are likely to remain common in February, as Michael Gifford of Old Mutual has explained. He views the recent rate cuts by central banks as "indicative" of the "scale and depth" of the current economic downturn, rather than signals of improving conditions. Consequently, Mr Gifford recommends safe fund investments in areas such as utilities and telecoms, which can offer "stable earnings" and "good dividend growth" in the face of ongoing market volatility.

Despite the commendable efforts of central banks to restore confidence in world markets, the uncertainty caused by last year's liquidity problems lingers on and many are likely to join Mr Gifford in taking a defensive approach until clearer signs of improvement emerge.