Jump to content
House Price Crash Forum

Under What Circs Do Interest Rates Rise?


Recommended Posts

That's interesting. So does the bank subtract something from its own saving when it creates the seller's saving?

It is a method to facilitate trade

Why do you the individual keep trying to change my individual experience?

There is nothing between us. We are just separate beings in time and space.

Your alter ego told me he was using NLP on me to drive me into submission and another time told me he was ramming it up my **** good and proper.

What kind of individualism is that?

Sounds like group sex to me

:lol:

Maybe it is a homosexual invasion of the body snatchers?

How come you anarchists are so hell bent on world domination

Doh!

Link to comment
Share on other sites

  • Replies 264
  • Created
  • Last Reply

Top Posters In This Topic

Earlier we established that if 100 cash is deposited and 100 cash lent out then infinite leverage is created. It must be infinite because if they left 1 penny in the bank and lent out 99.99 that would be 99.99 to .1 leverage. 1000 to 1. So as the penny approaches zero you get infinite leverage.

The bank can only do 0 deposit to create 1000 loans if no cash leaves the bank.

So we then ask the question how can the bank do that?

And the answer is very very simple. The bank creates a sellers savings when a buyer buys the sellers item using the banks services. the bank then wants the buyer to balance the banks liabilities to the seller.

We can make progress maybe if you focus on the realities rather than on the accountancy please.

I think you would be a lot better served spending a bit more time on the accountancy.

the banks books are balanced the moment that they create the mortgage and the credit in your account.

a banks books are never NOT balanced.

your fixation on "sellers savings" etc. is causing you difficulty.

Link to comment
Share on other sites

I think you would be a lot better served spending a bit more time on the accountancy.

the banks books are balanced the moment that they create the mortgage and the credit in your account.

a banks books are never NOT balanced.

your fixation on "sellers savings" etc. is causing you difficulty.

I am in no difficulty.

A banks books are an abstract method using symbols and words to describe what happens in the real world.

In the real world you cannot instantly write an account in a book. You have to begin with the asset or liability and add the rest to the line detail by detail. It is a method that helps you reconstruct what happened in reality.

But in reality the books are not the reality of the accounts because the reality of the accounts is described in the computer programs that manage the realities of the banks businesses.

And the computer accounts are no more real than the books.

What is real is what happens in the real world.

And so i made that suggestion to get you to think differently.

You are the one who tells me i am saying the opposite of what i said before.

My position was consistant.

Please dont treat me like a fool.

Link to comment
Share on other sites

As far as I know they don't set the price. They set the maturity value and a coupon (Set interest returns per year) , there is then an auction for these. So it is not the case of the Government dropping the price of the Gilts. It is a case of them raising the returns available on these purchased in an auction.

I am still not completely sure how raising coupon rates for Gilts will automatically equate to the BoE base rate having to rise. Why would the raising of the coupon to attract investors automatically mean the base rate goes up to ? Why can these not be independent ? I am sure there is a simple answer.

Anyone care to explain...

Anyone ?

Link to comment
Share on other sites

http://www.parkcaledonia.co.uk/markets/governmentbonds.htm

http://www.swap-rates.com/Definitions.html

http://www.swap-rates.com/InterestRateSwap.html

Googled the following:

coupon rates for gilts and relationship to base rates

Not sure if the above links help or not barely skim read them.

Cheers. I will have a read. Google to the rescue. Maybe.

Link to comment
Share on other sites

"The coupon rate usually reflects the market interest rate at the time of the first issue of the gilt and consequently there is a wide range of coupon rates available in the market at any one time, reflecting how rates of borrowing have fluctuated in the past."

So that doesn't seem to help much. 'Usually' is pretty washy. Also this relates to market interest rates and not the BoE base rate.

"The rate at which prime banks can borrow from the Bank of England. They use this as a base rate for general loans. The Bank of England Base Rate is set by the Monetary Policy Committee, which meets on the Wednesday and Thursday following the first Monday of each month (except in an emergency). Decisions of the Committee are announced at 12 noon immediately following the Thursday meeting."

Doesn't seem to help either. We know how the Libor rate has spread from the BoE rate recently so that link is by no means guaranteed.

"if the capital markets do not possess an infallible crystal ball in which the precise trend of future interest rates can be observed, the markets do possess a considerable body of information about the relationship between interest rates and future periods of time."

"In many countries, for example, there is a deep and liquid market in interest bearing securities issued by the government."

"It is possible, therefore, to plot a graph of the yields of such securities having regard to their varying maturities. This graph is known generally as a yield curve -- i.e.: the relationship between future interest rates and time -- and a graph showing the yield of securities displaying the same characteristics as government securities is known as the par coupon yield curve."

Interest rate swaps seem to give more of a link. There does seem to be a link between these swaps and the yields on Gilts.

However the question is still not answered:

Why can't the BoE not keep rates low - at the same time as increasing the coupon on Gilts ? What stops this ?

This is a very important point IMO. Pretty much everyone on here says that rates may rise in future, due to the necessity to increase the attractiveness of purchasers of UK Gilts. WHY do both go hand in hand ?

A simple answer would be nice if anyone knows ? Or is this just something that people have assumed ?

Cheers

Link to comment
Share on other sites

I am still not completely sure how raising coupon rates for Gilts will automatically equate to the BoE base rate having to rise. Why would the raising of the coupon to attract investors automatically mean the base rate goes up to ? Why can these not be independent ? I am sure there is a simple answer.

Anyone ?

This is an interesting question - and one for which I do not have a definitive answer. Historically there has always seemed to be a correlation - and these falling gilt prices (i.e. rising yields) have previously been used as the explanation of the need to increase interest rates.

I think there are many possible answers, but no straightforward ones - since, beyond dispute is the fact that the central bank rate can be set (at least in principle) by political dictate - even if, today, this needs to be done indirectly by way of setting a new target for the independent central bank.

The practical problems with very low base rates in the context of much higher longer term rates are manifold. One issue is that it dissuades longer term direct investment; another is that it introduces disproportionately large (low risk) returns for banks and hedge-funds who "borrow short" to "lend long". This would likely lead to moral hazard, where rather than supporting the real economy, financial institutions would be frantically profiteering from a one-way bet arising from an entirely artificial basis... which, in turn, might precipitate a currency crisis.

All this said, we are in a brave new world now - where, rather than using bond prices to guide setting base rates... instead, the central bank is attempting to intervene to set bond prices to reflect the base rate - which was, in turn, set indirectly (but solely) on the instruction of the Treasury. It isn't entirely clear how things work today... but, I suspect, rising bond yields (at longer maturities) would indicate an expectation of increased inflation in the medium to long term - hence justifying the BoE to raise base rates under the existing mandate.

Edited by A.steve
Link to comment
Share on other sites

Anyone ?

I will have a go

The gilt has a marked face value (a money amount written on the bond) and an interest rate payable over the term of the gilt

At the auctions the bidders hope to get a bond with a marked face value at a price below the face value so that the yield is higher for them.

Gilts also function as reserves so if there is a big demand for reserves then gilts are bid up and the yield is lower.

When too much money is flowing around the money markets then inflation rises. The BOE manages the cash in the market so that the settlement rate at the BOE is near the target. It reduces the money supply by selling gilts which it has on its balance sheet and this forces up the settlement rate to the target. So as it sells gilts their price falls and the yield rises. If it has to sell more gilts to remove money from the money supply it signals a higher BOE rate and defends that.

Link to comment
Share on other sites

This already happened. There was no panic afterwards and gilt auctions since have all been successful.

Seems to have happened twice

http://www.dmo.gov.uk/reportView.aspx?rptC...uction_Calendar

The 16th April looks to have failed to raise the full £4bn,

that is on top of the one reported in March

http://www.telegraph.co.uk/finance/economi...since-1995.html

Odd that the second failure didn't seem to get so much press!

Optobear

Link to comment
Share on other sites

The practical problems with very low base rates in the context of much higher longer term rates are manifold. One issue is that it dissuades longer term direct investment; another is that it introduces disproportionately large (low risk) returns for banks and hedge-funds who "borrow short" to "lend long". This would likely lead to moral hazard, where rather than supporting the real economy, financial institutions would be frantically profiteering from a one-way bet arising from an entirely artificial basis... which, in turn, might precipitate a currency crisis.

I think you are looking at that incorrectly

We are here now. Whatever errors were made in the past we have to deal with now. There is now tremendous deflationary pressures in the economy to drive down asset prices and create unemployment. The banks have to build reserves to have a buffer for loan losses and asset devaluation. That seems real to me. At the same time they are being assisted by the central bank to get a stronger balance sheet by being more profitable on their existing loans because they can borrow cheaper and lend at the rate which suits them and the market

There is no one way bet here. If the central banks are not successful in supporting the banks then the economy will totally collapse. This is a time of tremendous risk and distrust while the inbalances work themselves out.

Moral hazard is created when the banks that need to fail are not cleaned out and taken over so that existing managers believe they dont need to be prudent and can be reckless in the future.

Link to comment
Share on other sites

I meant only what I said - I chose my words carefully.

The only reason we know that interest rates will eventually rise is that they can't (meaningfully) fall further than they already have. Of course, as quantitative easing measures show - even with near zero base rates, a central bank can still manipulate the cost of borrowing longer term - and work to establish a specific yield curve as monetary policy.

None of us know the future... but we can anticipate possible dilemmas. The one I see arising through QE is a preference for shorter and shorter maturity on sovereign debt... essentially because, over time, it becomes more and more likely that investments with significantly better returns will emerge - and investors will be most anxious not to be excluded. If/when that happens, it is likely to lead to investors dumping gilts (forcing down the value of longer dated government debt) - thus forcing up the cost of borrowing on the open market independently of central bank base rates. It is anyone's guess when, or to what extent this effect will materialise.

The logical investment for anyone denominated in a low yielding currency is to invest somewhere with a higher yielding currency. This, if it happens on a grand scale will likely lead to preposterous bubbles in emerging markets - and put extensive pressure on exchange rates.

so what does it mean to have a bubble in gilts, as some appear to be claiming. That currently, gilts are a safe haven in an uncertain world. As confidence returns to the economy, and confidence returns in alternative investments you get the sell-off in gilts because investors will want greater yields ? and investment diverted to other areas...thus the bursting of a gilt bubble....

am i anywhere close to making sense ? surely to keep control of long-term interest rates central banks will need to extend queasing or do they have other tools at their disposal that aren't as well publicised.

Link to comment
Share on other sites

"The coupon rate usually reflects the market interest rate at the time of the first issue of the gilt and consequently there is a wide range of coupon rates available in the market at any one time, reflecting how rates of borrowing have fluctuated in the past."

So that doesn't seem to help much. 'Usually' is pretty washy. Also this relates to market interest rates and not the BoE base rate.

"The rate at which prime banks can borrow from the Bank of England. They use this as a base rate for general loans. The Bank of England Base Rate is set by the Monetary Policy Committee, which meets on the Wednesday and Thursday following the first Monday of each month (except in an emergency). Decisions of the Committee are announced at 12 noon immediately following the Thursday meeting."

Doesn't seem to help either. We know how the Libor rate has spread from the BoE rate recently so that link is by no means guaranteed.

"if the capital markets do not possess an infallible crystal ball in which the precise trend of future interest rates can be observed, the markets do possess a considerable body of information about the relationship between interest rates and future periods of time."

"In many countries, for example, there is a deep and liquid market in interest bearing securities issued by the government."

"It is possible, therefore, to plot a graph of the yields of such securities having regard to their varying maturities. This graph is known generally as a yield curve -- i.e.: the relationship between future interest rates and time -- and a graph showing the yield of securities displaying the same characteristics as government securities is known as the par coupon yield curve."

Interest rate swaps seem to give more of a link. There does seem to be a link between these swaps and the yields on Gilts.

However the question is still not answered:

Why can't the BoE not keep rates low - at the same time as increasing the coupon on Gilts ? What stops this ?

This is a very important point IMO. Pretty much everyone on here says that rates may rise in future, due to the necessity to increase the attractiveness of purchasers of UK Gilts. WHY do both go hand in hand ?

A simple answer would be nice if anyone knows ? Or is this just something that people have assumed ?

Cheers

I think you are wanting reality to be precise when reality is fuzzy.

The boe rate is not a rate. It is a target rate that varies. The BOE defends that target by actions in the money market with omo and money auctions in the day.

You say:

Why can't the BoE not keep rates low - at the same time as increasing the coupon on Gilts ? What stops this ?

The BOe manages the target rate by buying and selling gilts via omo.

if their is too much cash in the market then rates are too low for the target and it sells gilts (driving down their price) by buying cash to reduce the cash supply and raise the rate that is constantly varying around the target rate.

When the gilts are driven down in price as the bank sells gilts then since they have a fixed face value and a fixed interest rate their yield rises. Any gilt sales the government now does have to be pitched with a coupon that enables a buyer to get a similar yield

The whole thing is like chaos rather than order.

Link to comment
Share on other sites

Thanks for the replies. Interesting points and I fear this question will not have an easy answer !!

It seems these correlations are down to relationships that have occured in the past. However will these still work in the same way today ? A lot has changed so perhaps not.

The higher yields, the money supply, inflation expectations, etc..

I can sort of get my head around these relationships. However maybe these relationships are now broken. The money supply, inflation expectations etc... are in unchartered territories. Our own Government is buying our own Gilts with printed money to raise the price artifically and keep the yields low. This would, as Steve says, normally indicate low inflation expectations and therefore low BoE rates. However the market must know this is being artificially controlled.

As Aliveandkicking says it is the money supply that is central to many of these relationships. However the money supply is being messed around with in ways that have never happened before. On a scale that has never happened before. Are these relationships still valid ?

BoE keeps rates low to help homeowners etc..

+

BoE offers high coupon rates to encourage purchases of our Gilts.

= ?

Does the UK collapse as a result ?

Too many questions - too small a brain. :blink:

PS - Just seen your reply A&K. I agree. Chaos it looks like !! That is why I wonder why everyone takes these relationships as a given.

Link to comment
Share on other sites

Seems to have happened twice

http://www.dmo.gov.uk/reportView.aspx?rptC...uction_Calendar

The 16th April looks to have failed to raise the full £4bn,

that is on top of the one reported in March

http://www.telegraph.co.uk/finance/economi...since-1995.html

Odd that the second failure didn't seem to get so much press!

Optobear

But your link makes it clear it was only a partial failure in special circumstances where the gilts value to the investor was undermined by the comments made at that time by the governor.

Link to comment
Share on other sites

I think you are looking at that incorrectly

I don't - I think I was answering a different question to the sensible points you made. I'd assumed ccc understood that basis of money supply - but was asking why high gilt yields were necessarily incompatible with low base rates... in one sense, in my opinion, they are not... except that a very steep yield curve is likely unethical and politically unacceptable.

We are here now. Whatever errors were made in the past we have to deal with now. There is now tremendous deflationary pressures in the economy to drive down asset prices and create unemployment. The banks have to build reserves to have a buffer for loan losses and asset devaluation. That seems real to me. At the same time they are being assisted by the central bank to get a stronger balance sheet by being more profitable on their existing loans because they can borrow cheaper and lend at the rate which suits them and the market

There is no one way bet here. If the central banks are not successful in supporting the banks then the economy will totally collapse. This is a time of tremendous risk and distrust while the inbalances work themselves out.

Moral hazard is created when the banks that need to fail are not cleaned out and taken over so that existing managers believe they dont need to be prudent and can be reckless in the future.

The moral hazard issue I alluded to was theoretical - it assumed spiralling gilt yields and miniscule base rates. The unethical 'one way bet' would be to privately arrange massive short term borrowing against longer term gilts (on a private basis) and construct a massively leveraged fund creaming substantial annual profits - where all the risks are effectively underwritten by the taxpayer... a re-run of LTCM, sort-of.

This is why, I think, the BoE needs gilts to be over-valued if it is to keep its base rate low.

Link to comment
Share on other sites

so what does it mean to have a bubble in gilts, as some appear to be claiming. That currently, gilts are a safe haven in an uncertain world. As confidence returns to the economy, and confidence returns in alternative investments you get the sell-off in gilts because investors will want greater yields ? and investment diverted to other areas...thus the bursting of a gilt bubble....

am i anywhere close to making sense ? surely to keep control of long-term interest rates central banks will need to extend queasing or do they have other tools at their disposal that aren't as well publicised.

Although I dislike the phrase 'bubble in guilts' (since that suggests a scale of price inflation that isn't plausible) I think you're probably otherwise right.

If the difference between short term rates (influenced by the BoE base rate) get too out-of-whack with the bond yields, it shifts risk and reward in ways that are likely to be unpalatable.

Link to comment
Share on other sites

I can sort of get my head around these relationships. However maybe these relationships are now broken. The money supply, inflation expectations etc... are in unchartered territories. Our own Government is buying our own Gilts with printed money to raise the price artifically and keep the yields low. This would, as Steve says, normally indicate low inflation expectations and therefore low BoE rates. However the market must know this is being artificially controlled.

As I understand it, the biggest constraint on QE is market belief that the BoE & Treasury will unwind their positions - i.e. that the purchase is temporary. If the market perceives that the government is too scared of something to stop QE (and reverse the process) then I'm sure that ways will be found to exploit this for private profit at public expense (rather like with Soros and the ERM debacle...)

Link to comment
Share on other sites

Although I dislike the phrase 'bubble in guilts' (since that suggests a scale of price inflation that isn't plausible) I think you're probably otherwise right.

If the difference between short term rates (influenced by the BoE base rate) get too out-of-whack with the bond yields, it shifts risk and reward in ways that are likely to be unpalatable.

I see. Arbitrage opportunity ?

Borrow money at short term BoE rates and invest long in high yielding Gilts.

Initially the rewards would be obvious. However would this not balance itself out. If this easy opportunity was there - would others not just continue to jump in until the demand soared, and therefore yields dropped again ?

Link to comment
Share on other sites

Initially the rewards would be obvious. However would this not balance itself out. If this easy opportunity was there - would others not just continue to jump in until the demand soared, and therefore yields dropped again ?

No, most people would not be able to do this because they would not have access to the cheap finance. The cheap finance would be provided, probably, by erm - an almost nationalised bank... to, erm - maybe some senior ex-employees?

LTCM is instructive here - they were able to arrange massive leverage because their board of directors had Nobel prize winning economists among their number. LTCM crashed and burned spectacularly - arguably - nearly taking the US financial system with it in 1998... having operated with ~40% profits for ~4 years. They had little competition because very few had access to the sort of finance required - and of those who had access, few were as reckless.

Edited by A.steve
Link to comment
Share on other sites

Borrow money at short term BoE rates

I think this is an incorrect way of looking at the BOE system.

The BOE is the lender of last resort.

The Boe sets a target rate which i believe is a maximum rate they want reserve settlement to occur at overnight at the boe. You can also deposit with the Boe which is a minimum to reduce volatility.

The boe then defends the target in the money markets by providing or removing cash with various money market operations. When the regulated banks can access plenty of reserves then when the final settlement occurs at the bank of england overnight they want to lend out those reserves for a profit and the more plentiful the reserves are to the banks the less demand there is for a higher rate of interest at settlement for the banks with insufficient cash and ultimately any bank that cannot get sufficient reserves from a bank present at the boe settlement can go to the boe as lender of last resort but if there any funds available from other banks and the bank is trusted they will always be lent out at less than or very near to the lender of last resort rate.

But nobody goes directly to the boe at the target rate unless they are in trouble in the ordinary course of events other than for the few quid that is needed for the final overnight settlement if they together run out of reserves

So there is no BOE tap to feed from at the published rate.

Link to comment
Share on other sites

LTCM is instructive here - they were able to arrange massive leverage because their board of directors had Nobel prize winning economists among their number.

Leverage is not a function of cleverness.

It simply means the amount of debt you use compared to your own stake in the buisiness.

So if a bank has 1 cent of skin in the game and borrows 99.9 and lends 99,9 the bank has now levered its ability to earn 7 % on 1 cent by 999 times to enable it to get the margin between cost of borrowing and profit of lending 99,99 at 999 leverage or .1/99.9 or about .001% fractional reserve.

Leverage being fine until you lose a tiny amount of your borrowed money and have no hope of borrowing again to trade out of the mess.

Link to comment
Share on other sites

Leverage is not a function of cleverness.

It simply means the amount of debt you use compared to your own stake in the buisiness.

Oh, you misunderstand. Available leverage is a function of respect, social standing and industry perception. I suggest a compare-contrast with Madoff.

Link to comment
Share on other sites

Join the conversation

You can post now and register later. If you have an account, sign in now to post with your account.

Guest
Reply to this topic...

×   Pasted as rich text.   Paste as plain text instead

  Only 75 emoji are allowed.

×   Your link has been automatically embedded.   Display as a link instead

×   Your previous content has been restored.   Clear editor

×   You cannot paste images directly. Upload or insert images from URL.

Loading...
 Share

  • Recently Browsing   0 members

    • No registered users viewing this page.




×
×
  • Create New...

Important Information

We have placed cookies on your device to help make this website better. You can adjust your cookie settings, otherwise we'll assume you're okay to continue.