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What the central banker did


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David is a Currency Dealer with Halo Financial Ltd, delivering competitive exchange rates and a personalised service to help property investors, holiday buyers and migrants  throughout Europe save time, money and hassle on their foreign exchange transactions.

Money, or the lack of its availability, is central to the current financial market turmoil.

Banks are refusing to lend even to other banks unless they can make a substantial return. The premium they are placing on loans to the public is undermining efforts of central banks to allay fears of recession.

This is the case in many countries but the effect in the UK is very easy to identify. The Bank of England has already cut the cost of borrowing at its core but their action of dropping the UK base rate by 50 basis points since December 2007 hasn’t translated into lower borrowing costs across the UK. In fact, for many mortgage payers, the cost of their loans has risen because banks are charging a premium on the cost of lending to each other and that is calculated in the London Interbank Offer Rate (LIBOR).

This lack of follow through in the money markets has lead to central banks changing their tactics to try to get cheaper funds to the retail users. The Bank of England and many others are offering increased amounts of discounted funds to banks and financial institutions in order to make money more easily available and, through the powers of supply and demand, more affordable.

So far the plan hasn’t been particularly effective and the US Federal Reserve has adopted a savage exchange rate cutting policy to force the pace at which banks offer cheaper money to the public. By cutting their base rate (the Fed Funds Rate) and their market specific ‘Discount rate’ they have provided the money markets with ample liquidity and reduced the cost of credit for most Americans.

In an interesting contrast, the relatively benign conditions in the EU economy and, some would argue, the lower proportion of bought – as opposed to rented accommodation – in Europe, have left the European Central Bank with less pressure to cut interest rates and, if anything, with inflation relatively high, enough reasons to maintain interest rates at higher levels. In fact, most analysts are forecasting even higher EU interest rates in the months ahead.

The future

This combination of a robust economy and attractive interest rate yields is producing increased levels of safe haven Euro buying to the point that, against the US Dollar the Euro is twice as valuable today as it was just seven years ago. That is an astonishing move and one which is still costing German and French exporters sales.

Obviously, the most logical conclusion is that further Euro strength will indeed stall the growth in Europe and the Euro will finally fall substantially and the fact that it has increased in value by 100 percent makes the probability of a very significant decline all the more likely. I am sure that anyone in the UK with a plan to invest in European Property will be wishing for such an eventuality but while the Bank of England continues to lower the cost of UK borrowing, Sterling is likely to follow the base rate downward.

However, all markets are cyclical; the Pound will finally rebound, the Euro will eventually run out of buyers and the US economy will stop declining. The really lucky man is the one who knows which of these will happen first. As has always been the case, knowledge and timing remain the most valuable assets of all and in the current environment, knowing what the central bankers are doing and thinking is the key to risk avoidance.

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