‘Financing tomorrow’ is the theme of this year’s Association of Corporate Treasurers’ (ACT) conference, taking place in the UK port city of Liverpool. Among the factors affecting future corporate financing is the timing of any change to UK interest rates, with the Bank of England (BoE) keeping its benchmark rate at a record low of 0.5% since March 2009.
As keynote speaker Stephen Boyle, chief economist of the Royal Bank of Scotland (RBS) noted, over the subsequent seven years market intelligence on rates has consistently proved inaccurate, with regular predictions of an imminent rate rise not borne out. Received wisdom has now changed and many expect rates to stay on hold for at least three more years.
Boyle noted that real interest rates were actually been in decline long before the 2008-09 global financial crisis triggered sharp cuts: the fall began in the Eighties and was well underway by the following decade. The downward trend has been prolonged due to three factors. Firstly, underlying growth in the world’s advanced economies has slowed in the past 20 years and although the pace of innovation has been rapid this hasn’t fed through into economic growth.
The second factor has been a shift in how much consumers want to save and how much they are ready to invest. The motivators have been various, ranging from longer lives and inadequate pension provision to the Asian financial crisis of the late 1990s, which persuaded many of the region’s consumers to move from borrowing to saving. Third has been the sharp rise in global indebtedness since 2008, which has seen efforts to repay debt at the expense of consumption and investment, which have both fallen.
Do low rates matter? They have caused asset values to rise more sharply, while pension liabilities have ballooned, said Boyle. moreover “if we believe low interest rates are a long-term phenomenon, we should adjust our expectations of what projects will produce decent value,” he suggested.
One development that he doesn’t expect, despite recent speculation, is that the BoE will follow the lead of the European Central Bank (ECB) and four other central banks in pushing interest rates below zero. “Experience so far suggests that negative rates don’t work,” said Boyle. “in both Denmark and Switzerland, where rates have turned negative, it has failed to loosen financial conditions; indeed, if anything it has tightened them.”
Another topic high on treasury agenda in recent years has been commodity volatility, accompanied “by talk of super cycles and collapsing prices” as Andy Hartree, head of commodity market solutions at Lloyds Bank.
At a session on commodity hedging an audience poll found that more than nine in 10 of those present hedge foreign exchange (FX) risk in some form and around two in three hedge interest rate risk. However, only just over half engage in any form of commodity risk hedging.
As Hartree noted, projections made in mid-2014 on the future price of Brent crude would have given a wide range of potential price trends but none would have envisaged the sharp price fall that then occurred in the second half of the year. “A 25% change in commodity prices can have a 50% impact on a company’s gross margin,” he noted. “And in recent years the price of crude has risen or fallen by 25%-plus on nine separate occasions.”
Colleague Carl Paraskevas, a senior economist at Lloyds, noted that crude oil and gold are two of the world’s most important commodities. yet despite being the more consumable of the two, one troy ounce of gold currently buys nearly 26 barrels of crude oil, almost double the average figure of 13.1 over the period since 2000.
Last year saw a massive oversupply of oil as US shale production came onto the market in force. Low prices have pushed down the industry’s capital expenditure (capex) although the market should become increasingly more balanced over the remainder of 2016. indeed, Paraskevas expects the price to have recovered to US$55 by the end of this year and to reach US$69 by the end of 2017.
The current major capex reductions are likely to create a much tighter market position in two to three years’ time,” he predicted.
Not surprisingly, a conference session entitled ‘Brexit: Discuss the impacts of the referendum and prepare your business for all eventualities’ attracted a large audience.
According to Moritz Kraemer, global chief rating officer sovereign ratings for agency Standard & Poor’s (S&P), the immediate consequence of a referendum vote in favour of the UK exiting the European Union (EU) would be the country losing it’s remaining AAA credit rating from S&P.
Kraemer believes that today the stakes are much higher than when the UK last held a referendum on EU membership back in 1975, only two years after it had joined. “Today we don’t know what the alternative would be,” he suggested. “Brexit proponents know what it is that they don’t want, but are rather less clear on what they’d like the replacement to be.”
The consequences of Brexit would be a prolonged process of renegotiation, most likely conducted by a new government. More seriously, S&P has sounded out infrastructure investors and found that around half would be less likely to invest in the UK. The country is also heavily dependent on external funding, said Kraemer, with last year’s current account deficit at 5% of gross domestic product (GDP) a post-World War II record.
David Marsh, managing director of independent research group the Official Monetary and Financial Institutions Forum (OMFIF), believes that the implications of the referendum have steadily grown since UK prime minister David Cameron first mooted it in January 2013. Either he didn’t realise these at the time, or didn’t anticipate his party’s election victory last May, Marsh suggested.
The ECB has already held two special sessions this year on the potential fall-out from Brexit, which would probably include Greece following the UK to the exit door and similar referendums held in as many as 10 other EU member states.
However, Marsh believe that the ‘Remain’ camp will achieve a reasonable majority in the June 23 poll. “Project Fear is having an effect and the British people are generally quite conservative,” he observed. “The silent majority in favour of staying May only become evident on the day.”
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The statement issued by the bank also suggests that fiat currencies are superior, due to their price stability.