UK interest rate expectations have fallen lower still on this morning’s announcement, and the market is now pricing in a 50/50 chance of rates falling to 1.5% or 1.75% at the end of 2009, although rates are still expected to rise in 2010. Gilts have also continued to rally, with five-year gilt yields breaking new record lows today and 10-year gilt yields falling to 4.05%.

We continue to believe that UK interest rates will go lower than expected, and stay lower for longer. We also strongly believe that gilts will continue to rally as inflation falls sharply over the next year, and we see the potential for double-digit returns for gilts over the next 12 months. UK investment grade corporate bonds should do at least as well as gilts, given that the average UK investment grade corporate bond yields 4.7% more than gilts.

Peter Waller - Investment Director

 The UK base rate is currently at 4.5%, and, as at last Wednesday, the UK bond market was pricing in UK base rates of 3.5% by this time next year (which would be level with where they were in mid-2003). As at midday today (22 October), the market is now pricing in a 50% chance of interest rates at 3.25% and 50% of rates at 3% by October 2009. They are then expected to start rising again in 2010.

M&G fixed interest team believes market still not pricing in sufficient rate cuts

 The team continues to believe that the market is being too conservative in its expectations for interest rate cuts, and that rates will stay lower for longer than the market is pricing in. Without aggressive monetary policy action, the UK housing market will continue to fall rapidly. It expects UK inflation to fall below 2% next year, and possibly below 1%. The Bank of England is likely to slash interest rates to avoid deflation as it would increase the future value of debt and therefore be very detrimental to the heavily indebted UK economy, .

 It is impossible to say where interest rates could reach since we do not know how the UK economy will react - if they reach 2.5% and there is no response, they could be cut to 1.5%. If there is still no response, they could potentially fall to zero. And if there is still no response, then the UK would enter the ‘Japan scenario’. But if interest rates reach 2.5% and consumers start spending again, then further rate cuts would not be necessary and the team’s view would change.

 Until we see a stabilising housing market and a resurgent consumer, or until the bond market fully prices in a long series of interest rate cuts, then we will remain long duration across our investment grade funds.

Peter Waller - Investment Director

Following top level talks this weekend there is at last, a package in place across europe which may and I hope does, extend into the USA which should bring calm back to the markets.  It should also get the flow of money pumping into the financial system.  Business and ordinary people will be able to borrow again.  It seems recession is inevitable and there will still be pain to pay for the decisions made by greedy bankers who arguably pushed capitalism to the brink.

These are times for all our clients to try and reflect yet again on their attitude to risk because it is in extreme times like these that resolve is really tested.  Please remember you have a choice of portfolios with Risk Levels ranging from 1 - 10.  This period has been a great test for all these portfolios and I am pleased to say they have all performed exactly as they should have done in extreme market conditions.  So, please check again that you are suited to your chosen risk profile and have a word with us if you are in any doubt.

Please Click Here to See the Performance of our portfolio (Risk Profile 5) of unit trusts and oeics over this last month.  The diversification story speaks for itself. At a time when the FTSE100 lost 26.6% the portfolio fell by 13.6%.

Diversification is the key to success and our portfolios major in on this aspect. The link to all our portfolios is here - just click.

I have attached below, three links which may help at a time like this.

The first - UK Stockmarket Recoveries details the history and recoveries of 5 previous crashes. The second - Keeping Faith - The 1987 Crash explains why it is important to focus on the bigger picture, which is the longer term.

The third,  Keeping Faith with Equities reminds us that whilst equities can be volatile, staying with them brings rewards. Often the best returns come in very short periods. 

At a time when inflation will nose dive and interest rates will follow suit, sticking to a well diversified portfolio should bring about very positive returns going forward.

Peter Waller - Investment Director

Five stockmarket recoveries.

How to survive stockmarkets ups and downs.