Following the global coordinated interest rate cuts in October 2008 in the aftermath of the Lehman Brothers bankruptcy, interest rate levels across most central banks remained at their historically low levels during the past 12 months. So far only a few central banks have embarked on a route to monetary policy normalisation, including the Reserve Bank of Australia, the Norwegian Central Bank and the Bank of Israel.

Many economists have been discussing when the major central banks will also begin their "exit strategies". The key question for many is: How long will it take for the Bank of England, the US Federal Reserve and the European Central Bank to also follow suit?

Following the November monetary policy meetings by all the three major central banks, various international economists have been reviewing their expectation for interest rate levels over the coming year. The UK's Monetary Policy Committee agreed to extend the asset purchase scheme by £25 billion. The BOE's decision to expand quantitative easing followed a report issued on 23 October showing that the UK economy unexpectedly contracted in the third quarter of 2009.

The UK economy shrank 0.4 per cent in the three months through September, extending the contraction to six consecutive quarters - the most since records began in 1955 - while the US, Germany, France and Japan have shown signs of returning to growth.

Despite upward pressure on prices in the near-term possibly given the continued weakness of sterling, inflation within the UK is likely to undershoot the two per cent target.

Moving into the US, the Federal Reserve signalled that a return to economic growth alone won't justify higher interest rates and an increase in rates will depend on when the labour market and inflation pick up. The Fed's rate-setting Open Market Committee restated its pledge to keep rates "exceptionally low" for an "extended period".

Across the eurozone region, against a background of slightly greater optimism on the outlook for the economy (as the European Commission said that the economy will expand by 0.7 per cent in 2010 against a previous forecast of a 0.1 per cent contraction), during the recent November meeting the ECB President gave a clear indication that the ECB was ready to begin "phasing out" some of its emergency measures taken to combat the economic crisis.

Since future interest rate levels will be set on the basis of the outlook for inflation and in the absence of inflationary pressures either next year or the year after in the US, UK and also in the euro region, various international economists continue to believe that rate increases will not take place during the course of 2010.

Therefore the current rate levels of the ECB (one per cent), the Fed (0.25 per cent) and the BOE at 0.50 per cent are expected to remain on hold next year. Interest rates are only expected to move higher during the beginning of 2011 with the US Funds rate forecast to jump from 0.25 per cent at the end of 2010 to over two per cent during the following year.

The ECB refinancing rate and the UK bank rate are also expected to rise above the two per cent level in 2011.

Against a background of record low interest rate levels in the eurozone area, including Malta, one would expect local investors to continue to search for higher returns on their savings. This has wide implications on the local financial market. This year will be remembered as the year of the corporate bond market with over €260 million raised through the local financial market by the various issuers.

Most of the bond issues were heavily oversubscribed as investors increased their exposure to a portfolio of local corporate bonds in order to achieve a more meaningful return on their investments. Given that interest rates in Malta are expected to remain at these historically low levels during 2010, one can expect another buoyant year for the bond market with continued high levels of subscriptions by investors.

Moreover, from a bond issuance perspective, while various new companies may be seeking to tap the market to finance their expansion or replace current bank borrowings, the activity on the market may be enhanced by the several redemptions which are due next year.

The above table lists the various bonds up for maturity in 2010 totalling the equivalent of €133 million together with a further €43.4 million also with the option of an early redemption in 2010. Should a number of these companies issue new bonds to finance the bonds being redeemed, 2010 could turn out to be another very busy year for the local bond market.

Coupled with this, the Bill tabled in Parliament last week to implement the 2010 Budget measures authorises the government to raise up to €550 million in new Malta Government Stocks next year. The proceeds are intended to finance the budget deficit (estimated at €239 million), the MGS redemptions totalling €191 million in February, June and November and also possibly effecting changes to the overall debt structure of the government by issuing new MGS as opposed to increasing the amounts of Treasury bills.

The equity market could also benefit from this prolonged low interest rate environment as some investors are attracted to the appealing dividend yields offered by some companies and increase their equity exposure given a more optimistic scenario following the very encouraging full-year results of Bank of Valletta.

The September 2009 financial statements of BoV have given a slight boost to the local equity market with the benchmark index gaining 5.5 per cent in recent weeks. Although the recent upturn in the MSE is dwarfed by the stronger recovery across most international financial markets, 2010 could also see an improved domestic equity market performance if listed companies provide encouraging news.

Mr Rizzo is director of Rizzo, Farrugia & Co. (Stockbrokers) Ltd.

Rizzo, Farrugia & Co. (Stockbrokers) Ltd, RFC, is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It has not been disclosed to the issuer/s herein mentioned before its publication. It is based on public information only and is published solely for informational purposes and is not to be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and other relevant persons may not trade in the securities to which this report relates (other than executing unsolicited client orders) until such time as the recipients of this report have had a reasonable opportunity to act thereon. RFC, its directors, the author of this report, other employees or RFC on behalf of its clients, have holdings in the securities herein mentioned and may at any time make purchases and/or sales in them as principal or agent. Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. Past performance is not necessarily indicative of future results. Neither RFC, nor any of its directors or employees accept any liability for any loss or damage arising out of the use of all or any part thereof and no representation or warranty is provided in respect of the reliability of the information contained in this report.

© 2009 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved.

www.rizzofarrugia.com

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