Future interest rates

Q Most of my money is held on deposit in euros, sterling and US dollars. I have tended to have one- to three-month deposits at any one time as I do not wish to lock the money away for too long. My bank are suggesting that I place a large amount into a one-year fixed deposit in euro and dollars. Is this advisable as interest rates seem to be going up in these currencies?

A The amount to be held in very liquid form, i.e. less than three-month deposits, will of course depend on your own personal requirements. Everyone should have a certain amount on short-term deposit to act as an emergency fund, for example for unexpected large expenses.

I generally recommend that an emergency fund equal to one year's earnings/income as a general rule of thumb. If you are locking money away for one year as opposed to three months, then you should only do so if you are firstly receiving a higher rate of interest by doing so and secondly if you expect interest rates will not rise further over the next year.

One cannot accurately predict what interest rates will be in that time but the general consensus is certainly for rates to continue to climb in both the euro and US dollar, and possibly also in sterling.

A lot of panic has set into global stock markets recently on the back of inflationary fears and the need to aggressively raise interest rates. If you believe what these analysts are saying then locking into a one-year fixed deposit does not make sense unless the rate of interest is around 0.5% more than the present three-month rate you are receiving. I say 0.5% as I expect euro and dollar rates to increase by about this amount over the next year.

This view is confirmed when you look at the one-week, three-month and 12-month LIBOR rates on the currencies as follows:

EUR USD GBP
1 week 2.56% 5.04% 4.64%
3 months 2.98% 5.28% 4.72%
12 months 3.39% 5.47% 4.97%

If you take the euro as an example, a very short-term deposit should be yielding you approximately 2.5%, whereas a longer term deposit of one year should certainly yield you over 3%.

I therefore suggest that you first ascertain the rates of interest being offered by your bank and if they are not offering you sufficiently more, then you should either shop around for better rates or alternatively keep shorter term deposits. The latter will give you more flexibility as interest rates move.

A final point to make is on the exchange rate risk. The US$ is very unattractive, with further declines against the euro anticipated. You may wish to consider selling a percentage of your dollar holdings if you also believe the dollar will slide further.

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. 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.