UK Interest Rates
UK interest rates – as defined by the Bank of England’s base rate – are the lowest they have been in history. They have been this low for 28 consecutive months. And, at 0.5 per cent, they cannot be cut further. Some economists had expected rates to start moving up in the autumn, but minutes from July’s Monetary Policy Committee meeting suggested that the possibility of a rise in interest rates in the near term had fallen.
Recovery in the UK was seen as far too fragile by all nine members of the MPC who recently voted against it, and the US has tied down short term interest rates until 2013. We would expect to see two positive quarters in a row before the situation changes. While the ECB acted to protect the German economy by raising rates, European banks are unlikely to do so again and given emerging economic data, an interest rate cut may be more likely in Europe.
How aggressive the Bank of England can afford to be when it comes to increasing the base rate will be dictated by how well it feels that the UK economy can handle the extra pressure that an increase would bring. It will not just be the words of the Chancellor that the markets will need to analyse but also the minutes of the previous Bank of England’s meeting.
It is with these policy decisions that traders spread betting on Sterling need to be aware of as any change in government nuance can lead to aggressive changes to Sterling strength in very short periods of time. It is not uncommon for a currency cross to spike both up and down seconds after comments are made before settling on a directional sentiment.
Short Sterling Spread Betting
With short sterling spread betting, you are betting on where the interest rate is going to be in a few months time. The actual spread betting values are 100 minus the interest rate (multiplied by 100), so you must remember that if the interest rates go down, this is equivalent to the short sterling spread bet going up, and vice versa. If you take a long position, then you are betting on the interest rate going down, and if you sell or take a short position, then you bet that the interest rate is going up.
The current price for short sterling three months out is 9885 – 9887. If you decide that the interest rates are going down, then you might buy at £14 per point. Suppose that the interest rates fall, and the spread bet quote goes up to 9897 – 9899. You decided to close your bet, selling the position at £14 per point at a price of 9897. As always with spread betting, it is easy to work out your gain or loss simply by multiplying the points and the stake.
- Your bet was opened at 9887
- Your bet closed at 9897
- The difference in points is 9897-9887
- You made a total of 10 points
- For a stake of £14 per point, you have made a profit of £140.
If the interest rates had risen, making the spread bet values go down to 9879 – 9881, you could close your bet and limit your loss. In this case –
- Your bet was opened at 9887
- Your bet closed at 9879
- The difference in points is 9887-9879
- You lost a total of eight points
- For a stake of £14 per point, you lost £112.
Looking at the current figures, it seems that the market expects interest rates to keep falling, even though they are already very low. The short sterling quote for a year out is 9892 – 9894. As you can see, there is not much room for the price to change because of the way it is calculated, so spread betting on short sterling you will tend to use larger stakes.
Perhaps you think that the recovery will be sooner, and interest rates will be increased or at least stay the same. In this case you might want to place a sell bet at 9892 for £50 per point. In the course of time, this spread bet quotation moves to 9881 – 9883, so you close your bet and take your profit.
- You opened your bet at 9892
- You closed your bet at 9883
- Therefore you gained nine points
- Your original stake was £50 per point
- Your total winnings are £450.
Once again, the market may go in the opposite direction to that which you anticipate. Say it went out to 9897 – 9899, and you decided to close your bet to cut your losses. Your short bet would close at 9899.
- You opened your bet at 9892
- You closed your bet at 9899
- This means you lost seven points
- For the stake wagered, you have lost £350.
How to Spread Bet Short Sterling
Spread Betting on Short Sterling may be confusing at first, but is easy once you understand it. First, to get one term out of the way, “short” does not mean what it usually means in trading, which is that you are betting on the value of a financial security going down, the opposite of placing a long bet or buying. In the context of short sterling, short has the natural meaning applied to the length of time. Just as you can spread bet on gilts or Treasury bonds, and you are betting on the rate of interest offered by the government over a period of years, betting on short sterling is betting on the rate of interest over a short period of time, just three months.
So to spread bet on Short Sterling means that you are taking a bet on the interest rate such as LIFFE or LIBOR, effectively the rate over the next couple of months, and not years out. You’re not betting exactly on these rates, because the value will vary with the market sentiment, and is not controlled by the Bank of England, but the value is closely related.
The other point to bear in mind, and this is common to all spread trading on interest rate products, is that the actual number quoted is 100 minus the interest rate in percent, and then multiplied by a hundred to make a reasonable size. So when the interest rate goes up, the spread trading short sterling value goes down; and when the interest rate goes down, the short sterling value goes up.
This is easier to work out than it might sound, so here is an example. Say the interest rate is 4%. To work out the short sterling value, take 100 minus the rate of 4, which gives you 96, then multiply by 100 to get the value of 9600. It is nearly as simple to work back from the spread bet quote to see what interest rate is being assumed. The current rate with IG Index is 9885 – 9887 for a futures style bet three months away, and this shows that the anticipated interest rate is 1.15% (100-98.85) – 1.13% (100-98.87).
It is obvious that this value is highly dependent on the current short-term interest rates, and on any immediate news that will affect them. Therefore it helps if you can keep up on the news about the economy, and in particular what the Bank of England is likely to do in the near future. Technical analysis also works for the reason that it can reveal the market sympathies, and other market participants are also keeping up on the news and reflecting that in their trading. If you bet solely on the basis of where you think the interest rate is going, then you may find that you are a little disconnected from the market; you should always let the market tell you which way it wants to go, rather than betting on where it “should” go.
Reportedly, one Spreadex’s punter made a £2120 bet in November 2008 betting on a sharper BOE’s interest rate reduction than the 1% expected by buying Spreadex’s short sterling futures market at 95.80 at the time. The market moved up sharply to 96.31, netting him 51 times his £2120 stake!
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