Stalemate in the Eurozone has seen interest rates in the UK remain near historic lows. Meanwhile inflation peaked in September 2011 registering 5.2% - well above the BoE's target 2%.
"The Bank of England expects CPI inflation to come down at some point in 2012, although exactly when is unclear," says Andrew Highman, Managing Director, Risk Solutions at Barclays. "The predicted timing of interest rate rises continues to be pushed out as the strength and timing of any economic recovery suffers from the on-going deadlock in the Eurozone."
According to Highman, the economists at Barclays expect the base rate to rise from the current low of 0.5% to 1.0% by the end of 2013 and to 2, 3 and 3.5% by end of 2014, 2015 and 2016 respectively. "But forecasts are just that," he warns. "There may be more false dawns before rates tick up, as the unquantifiable impact of the European debt storm continues to rewrite the history books."
The problem is that the low interest rate environment has become the 'new normal' for corporates. "Firms are increasingly hedging against exposures to foreign exchange rates and commodities, but fewer are engaging in interest rate hedging," says Highman. "This change in focus is partly understandable as management teams have not had to worry about a change in the base rate since March 2009 and even then the rate was falling. The last rise in the UK base rate was in July 2007."
Has your company been lulled into a false sense of security around interest rates? Are you prepared for a rate rise? According to Highman, "Some may argue that such pro-activity is a little premature but it is not uncommon to see farsighted management teams planning three to five years ahead."
"You do not have to go far back in history to see how a similar interest rate environment caught some US corporate treasurers out."
"Even before the tragic events of 9/11 the Federal Reserve's Open Market Committee (FOMC) had already begun to reduce the Fed Funds rate in the preceding period, reducing it from a high of 6.5% to 3.5% as the US economy began to falter. The Fed Funds rate continued to fall after 9/11, bottoming out at 1% in 2003/4 before rising quickly in the space of just two years to 5.25%. Many treasurers had reduced their level of hedging during 2003/4, which left them in an uncomfortable position as rates moved rapidly back up."
So, why aren't more businesses planning for the future? The main issue, says Highman, is that current fixed rates are significantly more expensive than base, which puts a lot of borrowers off doing anything to protect themselves.
"We have seen a number of borrowers take advantage of capped tracker loans, which are designed to give borrowers the benefit of some of the positive features of both a floating and a fixed rate - low rates while they last with the added certainty that they will never pay more than a pre-determined cap.
Rather than a conventional uncapped 5-year loan of Base + 3.5%, a borrower could choose to pay Base + 4.0% with the total payable capped at 6.5%, for example. The borrower gets same rate protection in exchange for a small increase in the loan margin."
For example, if Base averages 4.0% over the period, the borrower with a conventional loan would pay an average coupon of 7.5% whilst the borrower with capped tracker loan would pay 6.5%, a saving of £500,000 over the life of a five-year £10m facility.
"Of course, actual savings will differ between businesses," warns Highman. "But, those which constantly evaluate risks in the widest sense, seek professional input and access to solutions to combat these risks, will be better placed to navigate the challenging economic environment."