The consensus is for higher interest rates in the US and Euroland on a three-year view, which has implications for anyone looking at money market accounts today
The London money market was historically where the major financial institutions bought and sold sums of money with each other for fixed periods of time and for fixed rates. The size of the deals in this market, typically in the millions, has historically made this avenue unavailable to individuals. These days, the traditional restrictive access to money markets has lifted, although much of the mystique has not.
In today's financial services arena, some banks will make money market accounts accessible to their individual and corporate customers, usually those who have sizeable amounts of money to deposit and know how long they want to tie their money up for. Nowadays, as competition becomes more intense, offshore banks will offer this type of facility from £250,000 (or currency equivalent), although it must be said that the average deposit is more likely to be considerably higher than this.
A typical money market account will offer a fixed rate of interest for the amount of time that your client wants to place their deposit for. The critical difference between a money market account and a normal deposit account is that they must specify the time frame that they want to place their deposit, for example seven days, one month, three, six or 12 months. It is very important to note that once they have set their deposit period, this cannot be broken.
Each time a money market deposit matures, interest is paid and the deposit may then be withdrawn in whole or in part or re-deposited for a further period on newly negotiated interest rate and terms.
Another important difference between a normal deposit account and a money market account is that the general rule of the longer they tie their money up for, the higher the rate of interest, does not apply to the money markets. The laws of market demand, as well as the future market expectations for interest rate yields and economic conditions both local and worldwide, are major factors in how the interest rates are set for deposits. In particular, central bank actions or projected actions have a distinct impact upon the interest rates being offered.
So, for example, your client could end up getting a higher interest rate if they place for a short period, if there is a general expectation in the market that the Bank of England will reduce rates in the future, or that there are market demands from major financial institutions for money to cover short-term cash flow needs.
The best way to approach the money market is with caution and to think of it as making a client's own personal fixed rate, fixed deposit "bond". There are advantages to this as they can plan precisely when their money market account will mature, which gives rise to tax planning opportunities (so that they can capitalise their interest just before they return to their home country, for example).
What the banks expect
When approaching a bank for a money market account, be aware that you will be asked for (a) the precise amount of money your clients want to deposit (b) the precise time period they want to put their money in for - they can specify a date or a number of days or months. You will then be given an indication rate. Unless you accept that rate there and then, it may not actually be the one that a client ends up with - it is an indication of the rate that they could get in the money market at that time and if, for example, they decide to open the account later that day, they may find that the rates have moved and you will be offered a new rate for their placement.
To manage this, some depositors give a range of rates that are acceptable to them, allowing the bank to make the placement at the best rate. In every other respect, opening a money market account will be pretty similar to opening a normal deposit account, that is, they will need to complete an application form, meet customer due diligence requirements and have read the terms and conditions applying to the account. Payments into and out of a money market account will normally be done by electronic funds transfers. As with all types of accounts, it is worth taking some time to ring around the offshore banks to establish who can offer your client the rate and account that will suit them best.
The outlook for the money markets in the UK is relatively flat. Having held base rate at 4.75% for 12 months, the Bank of England's Monetary Policy Committee (MPC) chose to cut the rate to 4.50% at its August meeting. It was kept at that figure at the meetings in September and October. Given that the decision to cut rates in August was only made by a majority of five to four, it seems unlikely that there will be a further cut in the near future. For much of the summer, the money markets were expecting a further cut to 4.25% before the end of the year. Sentiment has now changed as the markets are now expecting flat rates across the time horizon.
There is currently an unusually wide range of opinion about the prospects for interest rates, reflected in the rare division in view within the MPC.
Some commentators argue that the cut in the base rate was unnecessary and risks a rise in the inflation rate above its target level in the medium term. This view is particularly influenced by the recent strong growth in the money supply, which may indicate that households and businesses are building up liquidity in order to finance current and future spending.
At the other end of the scale, other commentators place their emphasis on the recent slow growth of the economy and, particularly, on the weakness of consumer spending. They argue that the economy will weaken further unless interest rates are cut. Depending on the degree of pessimism about the economy, forecasts project a base rate at the end of next year at between 4% and 3.50%.
The consensus view expects rates to follow the pattern implied by the money markets. This projects that GDP growth will strengthen modestly in the second half of this year and will rise above its trend rate (about 2.5%pa) in 2006. Demand will be boosted by the recent modest depreciation of sterling and the continuing robust growth of the world economy, and by the lower level of interest rates. In this scenario, inflation fluctuates narrowly around its target rate of 2% over the next two to three years.
Given the current division within the MPC, the committee can be expected to be very cautious about cutting rates.
Unlike the MPC in the UK, the Federal Reserve is in the process of tightening monetary conditions in the US to dampen future growth and concerns about inflation. The markets are reflecting these concerns with rates expected to rise from about 2.50% today to around 4.25% in three years' time.
The question for the Fed is about the timing of rate rises and not about the direction of short-term interest rates.
Market expectations have see-sawed over the past few weeks following Hurricane Katrina. Initial expectations were that the Fed would skip long-awaited rate rises in September. But sentiment has changed as the market has focused on the impact Katrina would have on energy prices and realised that the Fed's actions would have virtually no impact on the recovery of the Mexican Gulf region.
In Euroland, market expectations for euro interest rates reflect relative economic weakness and inherent inflationary pressures. Despite a perceived watering down of the stability pact, European governments have not been able to promote expansion.
While many commentators believe that the European Central Bank would like to hike rates to dampen potential inflation, economic weakness is likely to preclude this until 2007. Money market rates are expected to rise from a very low level of around 2.1% to about 3.75% over the next three years.
The London money market is where large financial institutions have bought and sold sums off each other, for fixed periods and at fixed rates.
Offshore banks now often offer corporate and individual clients access to this market, for sums of £250,000 and above.
Key difference between money market and deposit account is that in the former the client must specify the time frame they want to save their money for.
Money market account matures at a set point in time, so opportunities to tax plan around this.
Money market expects UK rates to remain at 4.5% for rest of the year.
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