FINANCIAL MANAGEMENT - 31.05.2011

Yield curve

UK interest rates

The UK bank rate has been at a record low level of 0.5% since March 2009. The bank rate is expected to rise during 2011 but there is considerable uncertainty as to when and by how much. As we are in unprecedented economic times, it pays to be aware of the yield curve and what it is indicating about the cost of money and the economic outlook.

What is the yield curve?

You will have noticed that rates usually tend to be higher on long-term loans and deposits than for shorter periods. A yield curve describes the relationship between interest rates and maturity. The yield curve is not a prediction of future interest rates, it is the rate now for borrowing or saving at differing lengths of maturity.

What does the future hold?

The Bank of England publishes two sets of yield curves daily, one on UK government bonds and the other on the London Interbank Offered Rate (LIBOR). The normal yield curve for both slopes from the bottom left to the top right, showing that interest rates increase the longer the term of the loan.

Tip. You can find details of the Bank of England yield curves at http://www.bankofengland.co.uk/statistics/yieldcurve/index.htm.

As financial controller, where you have borrowings that can be refinanced, a normal yield curve would indicate that borrowing on a short-term basis will be cheaper.

Tip. Where interest rates are expected to rise, it is usually preferable to take advantage of them sooner rather than later.

What else to look out for?

It is when the yield curve does not slope up gently from left to right that you need to be especially wary about your company’s borrowings or savings and the outlook for the economy.

Inverted. An inverted yield curve slopes downwards from left to right showing that interest rates on shorter term borrowings or savings are higher than for longer terms. An inverted yield curve tends to indicate worsening economic growth but with low inflation.

Tip. Where the yield curve is inverted, the best strategy would be to save in the short term and borrow over longer terms.

Flat. A flat yield curve indicates uncertainty about the economy.

Tip. If the yield curve is inverted or flat, revisit your financial forecasts, particularly your sales demand - this is likely to fall in an uncertain economy.

Steep. A steeply rising yield curve is a signal that the economy is expected to improve and so the price of longer term money is higher.

Tip. If this is the case, you should be considering fixing long-term rates.

For a yield curve, visit http://financialcontroller.indicator.co.uk (FC 03.09.11).