Interest rates have plunged to an all-time low as the Bank of England’s Monetary Policy Committee attempts to get the economy moving.
For many people this has meant good news with mortgage rates being forced down and those on tracker deals enjoying reduced monthly payments.
But savers have been feeling the effects with annual returns on investments greatly reduced.
So how can individuals best position themselves to benefit financially from any future interest rate movements?
Well, placing a spread bet on any potential forthcoming rises or reductions is just one way for smart investors to profit from the moves.
Financial spread betting traditionally works by speculators trying to predict future increases or falls across a variety of financial instruments from global indices or shares to currencies to commodities.
Spread betters usually ‘buy’ if they feel prices will rise above a spread company’s prediction, or ‘sell’ if they feel prices will fall below a firm’s quote.
However, spread betting on interest rates is unique in that it works in the opposite way.
For example, if you were looking to place a spread bet on interest rate movements with spread experts Spreadex, you would need to look at the company’s UK Short Sterling market.
Here, figures relate to a 100 point index and the quotes relate not to the Bank of England’s base rate but on the future prediction of Libor rates – the rate banks use when lending to each other.
Let’s say you see a quote of 98.46-98.50. This would represent a view that the future Libor rate will be between 1.5% and 1.54% (100-98.5 = 1.5 and 100-98.46 = 1.54).
So if you felt rates were going to drop to 1% you could choose to ‘buy’ on the price with a view on the level moving to 99.
But if you felt rates were going to rise to 2% you could opt to sell on the quote with a view on the level shifting to 98.
You spread bet by betting on each per 0.01 point movement. So, in each case above, if you had bet £10 per point movement you would have made either £500 (£10x50 points movement if the price moved from 98.5 to 99) or £460 (£10x46 points movement if the price moved from 98.46 to 98).
Obviously if you had got the trade wrong and the prices moved the other way, you would have lost money.
However, any losses can arguably be compensated for particularly if you were using this method of trading as a way to try and hedge against changes in monthly tracker mortgage payments.
For example, in the current market conditions, if one were to correctly forecast when rates were to ‘bottom out’ or to start rising again, they could offset any increase in their monthly payment.
In this case, if the individual made a winning ‘sell’ spread bet on the UK Short Sterling market (ie correctly predicting future Libor rates were going to rise) then any increase in the monthly payment would be compensated for by their winning spread bet.
However, if they got this wrong and rates did indeed continue to go lower then any loss in the spread bet would be compensated for by the resulting reduction in the monthly tracker mortgage payments.
All this may seem confusing at first glance and it is true that spread betting on interest rates has typically been an area only usually tackled by experienced or specialist traders.
However, more and more savvy speculators are being attracted to this area especially given the rate of reductions seen at the end of 2008 and the beginning of 2009.
Indeed, one Spreadex customer made more than £100,000 by correctly forecasting the Bank of England’s surprise 1.5% interest rate cut in November when the cut was reflected by a similar drop in the Libor rate.
Again, it should be remembered that the Bank of England’s base rate and the three month Libor rate can often be different figures.