Global rates cut was historic

Oct 13 2008 by Karen Dent, The Journal

ICOULD not let this week’s ShareWatch pass without talking about the unprecedented events of the past few days. On Wednesday, we saw history being made and decisions taken that will be discussed in schools and universities for years to come.

Never have we seen a co-ordinated response to a global crisis as we did last week when seven central banks across the world cut interest rates in a bid to stabilise the financial system.

The Bank of England, US Federal Reserve, European Central Bank, Bank of Canada, Swiss National Bank, Swedish Riksbank and Bank of China all cut their respective interest rates.

These actions were strongly supported by the Bank of Japan and followed a 1% cut in Australian interest rates from 7% to 6% at the beginning of last week. While many were expecting the Bank of England to cut interest rates, following a sharp deterioration in our economy, it was the earlier than expected announcement that provided an initial boost for the stock market.

Also, and arguably more important in the short term at least, there was the announcement by the Government would help re-capitalise UK banks and inject further liquidity into the financial system.

The Treasury announced a comprehensive package of measures that will see it invest up to £50bn in UK banks by acquiring preference shares in them as well as guaranteeing a maximum of £250bn of short-term debt in order to help restore confidence between banks. Furthermore, the Bank of England will increase the Special Liquidity Scheme, which exchanges sterling for currently less liquid collateral on a three month basis, to £200bn.

The measures announced have been well thought out and should hopefully help to kick start inter bank lending, which has all but seized up.

What does this mean for our banks and their shareholders? In short, shareholders in the banks that decide to take part in the capital injection (issuance of preference shares to the Treasury) will retain their equity stake when only a few days ago there were concerns a some institutions could face nationalisation. While this is clearly good news, the bad news comes in the form of a likely significant cut in shareholder dividends as the Government tries to ensure the taxpayer does not lose out.

We are now witnessing a change in the banking landscape as the price for Government intervention is more than likely to be increased regulation. As a result, most banks are unlikely, certainly in the short to medium term anyway, to achieve the share price heights they saw in early 2007 as well as the levels of profitability. Instead, these financial institutions are likely to become highly regulated, lower return businesses. There is usually an exception to the rule and in the UK this may well just be HSBC.

Gary Fawcett is assistant director of Brewin Dolphin Investment Management, Newcastle