Interest Rates

Length: 687 words

Food and non-alcoholic beverages contributed most to the upward movement in the CPI annual rate with Shop-bought milk prices witnessing an increase above 2% in March in contrast to a fall of 8% in 2006. (National Statistics, 2007). Bread, cereals and meat witnessed small upward effects while downward movements in the index were contributed by fruits. (National Statistics, 2007).

In addition, upward effects on the CPI were contributed by recreation and culture, transport, furniture, household equipment and routine maintenance while a large downward effect came from housing and household services, owing to a greater extent in the fall in the price of gas and to a lesser extent to a drop in the price of electricity. (National Statistics, 2007). See figures 5, 6 and 7. Figure 5 Source: UK National Statistics (2007) Figure 6

In the case of the retail price index upward pressure on the annual rate was contributed mainly by household goods, electrical appliances and food while minimal contributions came from housing and motoring expenditures. (National Statistics, 2007). On the other hand large downward contributions cane from fuel and light as a result of gas and electricity. (National Statistics, 2007). See Figures 8, 9 and 10. High interest rates result in

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a reduction in the present value of future cash flows thus reducing the net present value of investments as well as the attractiveness of investment opportunities.

(Bodie et al, 2002). Real interest rates therefore remain key determinants of business investment expenditures. (Bodie et al, 2002). Since interest rates affect interest payments, the demand for housing and high-priced consumer durables such as automobiles is largely determined by interest rates. (Bodie et al, 2002). The lower the interest rates, the higher will be the demand and vice versa. The figure 11 above shows the movements in interest rates based on data from the Bank of England.

It can be seen that the interest rates have been falling over the last 10years with an average figure of about 5%. This means that investment opportunities in the United Kingdom are becoming more and more attractive over the years. Budget Deficit. The budget deficit is the difference between government spending and government revenues. (Bodie et al, 2002). Budget deficits must be offset by government borrowing. (Bodie et al, 2002). Large budget deficits signal negative information as they can result to large amounts of government borrowing thereby forcing up interest rates.

(Bodie et al, 2002). This will lead to a reduction in the attractiveness of investment opportunities resulting from negative net present values of future cash flows. (Bodie et al, 2002). Public Sector March: ? 4. 6 bn current budget deficit Source: UK National Statistics (2007) In March 2007, the public sector showed a deficit on current budget of 4. 6 billion, compared with a deficit of ? 3. 0 billion in March 2006. (http://www. statistics. gov. uk/CCI/nugget. asp? ID=206&Pos=1&ColRank=2&Rank=224)

Concentrating on one month in isolation can give a distorted picture as movements can be erratic. In financial year 2006/07 the public sector recorded a deficit of ? 8. 8 billion compared with a deficit of ? 15. 3 billion in the financial year 2005/06. More generally, the public sector recorded deficits between 1991/92 and 1997/98 before moving into surplus in 1998/99. Deficits have been recorded since 2002/03. (http://www. statistics. gov. uk/CCI/nugget. asp? ID=206&Pos=1&ColRank=2&Rank=224)

An alternative measure of the public sector fiscal position is public sector net borrowing. This additionally takes account of capital investment. In March 2007, there was net borrowing of ? 8. 5 billion, which compares with ? 6. 6 billion in March 2006. The Budget forecast for 2006/07 was net borrowing of ? 35. 0 billion. Public sector net debt, expressed as a percentage of gross domestic product (GDP), was 37. 4 per cent at the end of March 2007, compared with 36. 4 per cent at end of March 2006.

Debt peaked at 44.0 per cent of GDP in 1997, its highest since the mid-1980s. The debt ratio then fell steadily as public sector finances improved, reaching a low of 30. 1 per cent in February 2002. Since then it has risen. The Budget forecast for the end of March 2007 was 37. 2 per cent. Net debt was ? 501. 0 billion at the end of March, compared with ? 463. 4 billion a year earlier. The Budget forecast for net debt at the end of March 2007 was ? 500. 0 billion. (National Statistics, 2007). (http://www. statistics. gov. uk/CCI/nugget. asp? ID=206&Pos=1&ColRank=2&Rank=224)

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