The future for interest rates

I have fixed deposits in both sterling and US dollars which mature in the coming weeks. They were both fixed for five year terms. I have the option of renewing these for a further five years or I can alternatively choose a shorter one or two year term with the bank I am with. Would you recommend a short or longer term period or should I look for alternatives to deposit accounts?

After years of falling interest rates to a 50-year low of 3.5%, the Bank of England recently raised interest rates by 0.25% for the third consecutive time to its present level of 4.25%. Many firmly believe that interest rates will continue to rise to possibly 4.75% by the end of 2004.

The recent rises have been down to continued growth in the UK which has also been evidenced by the strong performance of the UK stock market over the last year. The other main factor for raising rates has been to try and combat the acceleration of house prices in the UK which have been spiralling out of control. It is unlikely that the recent interest rate hike will put an end to double-digit annual house inflation but further rises this year should slow the rate of inflation more dramatically.

In the US, the Federal Reserve maintained the interest rate on the dollar at 1%. There is however growing expectation that the US will shortly raise interest rates like in the UK. The US has yet to raise interest rates since hitting 1% so any increases will be a clear sign that the US economy is seen as strong enough to cope with an increase.

If you share my view that interest rates on both sterling and the dollar are likely to rise in coming months then you should consider a short-term home for your cash in the meantime. While you may be offered a 4.75% fixed rate for three-years in sterling for example, the rate offered by the end of the year for the same term may well be higher. I would not therefore lock into a long-term fixed deposit at this stage. The same applies to the US dollar.

As you have not mentioned any other savings or investments, I am assuming all your wealth is kept in these deposits. While cash offers security, you are not diversifying into other assets, i.e. fixed interest securities and stocks. Both have their advantages which is why it is vital to diversify. Investing in the stockmarket can be done by including protected or guaranteed funds to reduce the risk.

In summary, I would look to short-term deposits but to also add a weighting into other asset classes, depending on your age, short-term and long-term commitments and general attitude to risk.

Mark Hollingsworth is the director of Hollingsworth International Financial Services - licensed by the MFSA to provide investment services under the Investment Services Act 1994 (IS/32457). Address any financial questions to: Mark Hollingsworth, c/o The Sunday Times, PO Box 328, Valletta CMR 01. Alternatively, he can be contacted on 2131-6298/9984-2614 (office hours) or e-mail mh@hollingsworth-int.com.

Past performance is no guide to the future and, except where amounts are guaranteed, the price of your investments (and the currency in which it is denominated) may fall as well as rise. Malta exchange control regulations must be observed. Your personal tax situation will depend on residence. Always consult a professional adviser. This article does not intend to give investment advice and its contents should not be construed as such. Readers are encouraged to seek professional advice on their personal financial situation.