-David Kuo, Director at the financial website The Motley Fool. The opinions expressed are his own.-

Go on. Admit it. You didn’t see it coming, did you? You never thought a member of the G20 nations would dare to break ranks and raise interest rates this soon.

But Australia has done just that. The Central Bank of Australia has increased the cost of borrowing by 0.25 percent to 3.25 percent. It is doing what it thinks is right for the country regardless of what the rest may think. Now, Asian countries, keen to avert another bubble, may follow Australia’s lead and ratchet up interest rates before long.

Of course, Australia’s economy is vastly different to the UK’s. It has huge deposits of iron, aluminium and nickel that are in demand by mineral-hungry China. That said, Australia did briefly flirt with a downturn, which it successfully corrected with 21 billion pounds of fiscal stimulus.

But the UK is not Australia. We do not have huge deposits of mineral, and we are not near fasting-growing Asian countries either. What we do have are consumers saddled with over a trillion pounds of debt following a decade of binge borrowing, and a national debt burden of similar magnitude.
Therefore, it is unlikely that we will experience demand-led inflation. In fact, consumers are saving more of their household income than they have done for eight years.

The most recent Office for National Statistics report shows that between March and June British households saved 5.60 pounds out of every 100 pounds of household income. That is very different from the first three months of 2008 when we not only failed to save any money, but we even borrowed 50 pence for every 100 pounds of household income.

That said, we are still some way off getting our overstretched household finances back on an even keel. So, the savings ratio could go higher. In fact, it is still some way short of the long-run savings-ratio average of 8 percent of household income.

And herein lies the problem for the Bank of England.

According to the paradox of thrift, high levels of savings in a recession can prolong the economic downturn. That is because two-thirds of economic growth comes from consumer spending. So the less we spend, the longer it will take the UK economy to recover from the slump.
So what is the Monetary Policy Committee to do?

It has already slashed interest rates to historic lows. But that has failed to stimulate consumer spending. It has pumped 158 billion pounds of fresh money into the coffers of lenders through quantitative easing. But the money has, as yet, failed to invigorate the ailing economy.

However, both those measures will, in time, achieve their goals. The risk is not whether they will work, but instead, whether they will work too well and stoke inflation. Just as no one expected Australia to hike rates this soon, our days of enjoying low interest rates may end just as abruptly, and without warning. So save and invest what you can now.

- David Kuo is director at The Motley Fool. The opinions expressed are his own.-

What is the collective name for a crossing of fingers?

Because that seems to be what the Bank of England’s Monetary Policy Committee members are doing. They are collectively crossing their digits in the hope that they have done enough to steer the UK economy out of recession.

They have pumped billions into the UK economy and it doesn’t seem to be having much effect – yet. That is unless you are a banker looking to bolster your balance sheet with freshly minted notes. Banks are happy to swap their assets for the Bank of England’s cash but remain unwilling to lend. Additionally, there is still uncertaintyabout the ability of the economy to grow unaided if the central bank should stop printing money.

And just when you think that things could not get any worse, it just did. It seems another problem has crawled out of the woodwork is inflation. The Bank believes inflation will be extremely volatile. It may fall in September but near-term inflation may exceed initial forecasts. But because it believes the rise in inflation will be temporary, the suggestion is that interest rates can be maintained at around current record low levels for some time.

However, low interest rates, low growth and low prospects of an economic recovery are spooking foreign investors. Sterling recently sunk to levels not seen for five months against the euro. It has dropped from 1.30 euro a year ago to 1.07 euro, though it has since recovered to 1.11 euro.
UK exporters will undoubtedly welcome the favourable exchange rate against our European trading partners. But the fly in the ointment will be more expensive imports from European.

German cars, French wines, Italian luxury goods, Spanish holidays, Irish butter and Dutch Edam cheese will all cost more.

Inflation is the unspoken effect of Quantitative Easing. It is something we need to guard against if we are to ensure that our nest eggs and investments are not eroded over time. Leaving any money you have in savings accounts may seem like a sensible and safe thing to do now. But over the long term, cash has a terrible record at beating inflation. Consequently, it is better to invest in assets that have a proven track record against rising prices.

If you have a mortgage on a property, now is a good time to pay down as much of the loan you can afford while interest rates are low. If you have money that you can afford to put away for five years or more then it should be invested in shares rather than allowed to idle in a savings account.

Crossing your fingers is not an option. Putting your money to work is because things just got a lot worse.

-David Kuo, Director at the financial website The Motley Fool. The opinions expressed are his own.-

It wasn’t supposed to happen. Shares were not supposed to rise between May and September. That is if you believe the old stock market adage that says you should sell in May and go away, and don’t come back until St Legers Day.

However, if you had heeded the advice this year, you would have missed a 13 percent jump in shares during the summer months. Other great times to have ignored the adage were in 1987, 1997 and 2005 when shares jumped 15 percent, 18 percent and 14 percent.

But before we dismiss the adage entirely, there appears to be some grain of truth to the quaint saying that has its roots in London’s sewers rather than London’s financial district.

The five months from May to September have not been rewarding for private investors in twelve out of the last 25 years. By following the advice, investors would have sidestepped the severe stock market falls of 2008, 2002, and 2001, when shares fell 19.5 percent, 28 percent and 17.8 percent respectively.

Additionally, selling your shares in May 1998 would have protected your portfolio from the collapse of Long Term Capital Management, which saw shares crumble almost 15 percent during the five summer months.

Selling your shares this year would not have been clever, though. The London market has climbed 13 percent between May and the start of September. The summer surge accounted for almost all of the stock market gains to date this year.

Of course, if you stare hard enough at any set of data a pattern will eventually emerge. It may not mean anything useful, but it is a pattern nonetheless.

On the face of it, the summer months do not appear to be the best time to hold shares. The London stock market has risen around 8 percent a year between 1984 and 2008. By comparison, shares have fallen around 0.7 percent during the summer months of May through to September. Therefore, selling in May and buying back in September could be marginally beneficial.

However, it is important to consider other factors before you liquidate your portfolio at the start of every summer. It is essential to take into account selling and buying costs of around 3 percent of your portfolio value. Then there is Capital Gains Tax to pay if your gains exceed the current allowance of 9,600 pounds. And don’t forget you will have to forgo your dividends too.

So where next for shares? Should we liquidate our portfolios and lock in the gains for this year?
Truth is shares were ostensibly cheap following the sell-off in 2007. Consequently, the rebound was not unexpected even if it did happen in the summer of 2008. However, the speed and magnitude of the recovery did take many by surprise. And now that the low-hanging fruits have been plucked, peeled and baked into a pie the next stage will be more tricky.

The economic recovery, which is likely to take years, could be slow and anaemic. High levels of corporate failures will be a key feature as undercapitalised and highly indebted businesses find it increasingly difficult to secure finance. Consumer spending will remain subdued as shoppers keep their spending belts tightened. The upshot is a torrid time for many businesses.

The trick for investors now is to find companies with strong balance sheets and manageable debt that will benefit from any economic recovery. These companies do exists and their growth should spur the next stage of the stock market recovery, which may not occur overnight, but will happen over time.

- David Kuo is director at the Motley Fool. The opinions expressed are his own.-

If you are not confused you are not paying attention. Those sage words from management guru Tom Peters can be applied to a wide number of economic issues today, but none more so that to the latest inflation figures.

Question is: do we have inflation, deflation or some mixture of the two?

The answer lies in which index you are looking at?

Inflation as measure by the Consumer Prices Index (CPI) has held firm at 1.8 percent. But according to the Retail Prices Index (RPI), which excludes mortgage costs, inflation for July came in at minus 1.4 percent - that’s up from minus 1.6 percent in June.

So if you are a homeowner with a mortgage, then your cost of living is 1.4 percent lower in July than a year ago. But if you don’t have a mortgage, then the basket of goods that you regularly buy is 1.8 percent higher than a year ago.

The stickiness of the Consumer Prices Index, whilst the UK is in the midst of the worst recession for decades, poses an interesting problem for the Bank of England. In theory inflation should be lower as demand for goods and services are restrained by a fear of unemployment. Retailers, for instance, have been cutting prices to drive growth. Yet core inflation refuses to drop.

This raises the question as to how quickly inflation may rise when the UK economy eventually emerges from recession. For instance, how soon will the rise in the price of oil this year start to seriously drive up the cost of goods?

Additionally, with signs of a nascent recovery in Asian economies, how quickly will increase in demand start to affect prices in the UK? It is naive to ignore the purchasing power of the Asian consumer, which can have a direct impact on the cost of raw materials, minerals and food on the West.

Another area of concern lies in the extent to which quantitative easing by the Bank of England is storing up price pressure in the future. The Bank of England has increased the amount of money it will pump into the UK economy by 50 billion pounds to 175 billion pounds. But the big question is whether the Bank of England can mop up the money quickly when the economy starts to grow.

It is easy to consider inflation as an irrelevance now. But it would be wrong not to guard against inflation in the future. For starters, VAT will be restored from 15 percent to 17.5 percent in January. This will immediately push up consumer prices. As a consequence, the Bank of England will be forced to take action by hiking rates.

So, enjoy low inflation while it lasts. If you have debts, try to pay them down quickly while interest rates are low. If you are debt free, then consider investing in inflation-beating assets. Historically, only two asset classes have successfully beaten inflation. These are property and shares. So, if you already own a house, then start investing in the stock market now.

-David Kuo is director at the Motley Fool. The opinions expressed are his own.-

Banks insist on the right to charge customers who go overdrawn on their current accounts. They also say they have a right to set the amount charged.

The Office of Fair Trading (OFT), on the other hand, claims that the fees banks levy on customers who exceed agreed overdraft limits are unfair. This is according to their interpretation of the Unfair Terms in Consumer Contract Regulations.

The ding-dong battle has been going on for years. Round One, which was heard in the High Court, went to the OFT. Round Two in the Appeal Court went to the OFT too. Round Three is being heard in the House of Lords.

The stakes are high. Collectively, banks that include Lloyds Banking Group and Royal Bank of Scotland stand to lose almost 2.5 billion pounds in revenues every year if they aren‚t allowed to charge customers up to 40 pounds a time for going overdrawn without permission. Additionally, banks will have to refund customers who have been wrongly charged in the past if they lose.

Banks probably have a good inkling they are on shaky legal ground. Consequently, they have been refunding charges, and often in full, when confronted by disgruntled customers. But from a moral standpoint, shouldn‚t banks be allowed to charge customers who abuse overdraft facilities.

And therein lies the problem. Should customers who neglect to take care of their finances be continually subsidised by those who ensure that they maintain a healthy cash balance at all times? On the other hand, should financially disadvantaged customers be further penalised to allow others enjoy free banking?

Neither is correct if we accept that overdrafts are a privilege rather than a right. And with today‚s sophisticated information technology, there is no earthly reason why banks cannot properly control the outflow of money from customers‚ accounts that would stop them from ever going beyond their agreed overdraft.

But then again, why should they? Don‚t bank customers have some responsibility to regularly check and ensure that their accounts stay out of the red?

Clearly mistakes have been made and correcting the mistakes will be costly. Banks will insist it current accounts are essentially loss-making and costs money to provide. But how much of that is the fault of antiquated banking practices that breed complacency and inefficiency.

The eventual outcome of the “unfair bank charges” case is a foregone conclusion. And a major shake-up of the outdated British banking system will happen as a result. Inefficient banks will attempt to mask their incompetence with a clumsy introduction of fees and charges. Efficient banks will cross sell and gain market share.

But banking as we know it will change.

- David Kuo is director of financial website The Motley Fool. The opinions expressed are his own.-

The housing market is probably one of the most keenly followed markets in Britain. Every month we are hit between the eyes with no fewer than eight separate indices that provide pointers to the state of play in the property market. These include supply side figures from Rightmove, demand side numbers from Nationwide and mixed-adjusted indices from the Department of Communities and Local Government.

The plethora of indices is enough to make anyone draw the curtains and lie down in a darkened room. But it is important to appreciate that each set of data will be different because they are drawn from very different data pools. For instance Rightmove’s index is based on sellers’ asking prices, which tend to be more optimistic than say, Nationwide’s index which is based on agreed sale prices. Additionally, Nationwide’s index is derived from mortgage approvals, and not everyone may need to apply for a mortgage.

Our anxiety over house prices probably stems from the fact that a home is the single biggest purchase that most of us will make in our lives. So, it is understandable that we want to know that our money is well spent. Worryingly, there are some seven million people who are hoping that rising house prices will save them from poverty because they have not put away enough money for their retirement.

If you are wondering if house prices have bottomed, the answer is probably not. Currently, the price of a typical home in the UK is around £153,000, which is still six times the average annual wage of a British worker of £24,000. The cuts in mortgage rates have helped to ease the burden of servicing mortgages. However, there are dangers to relying on low interest rates.

Whilst house-price watching is a popular national pastime, and one that I have to do professionally, it has never interested me that much on a personal level. That’s because I have neither considered my house as either an investment or as a substitute for my pension.

I have always thought of my home as a roof over my head that meets my living needs. After all, if I didn’t buy one then I would have to pay rent to a landlord, which wouldn’t bother me too much. At least as a tenant I wouldn’t find myself knee-deep in sewage unblocking a drain with a plunger on a sunny Sunday afternoon.

During my twenty or so years as a homeowner, I have seen property prices rise and I have also seen them fall. That said, over the long term I have been fortunate to benefit from rising house prices. The appreciation in property values has allowed me to steadily build up equity in my home albeit punctuated by periods when prices fell. Nevertheless, house prices would now need to drop quite significantly to catch my attention.

Clearly, adopting a relaxed attitude towards house prices has taken many years of practice. It has also been helped by regularly channelling money into other assets such as the stock market, bonds and cash. By doing so, the value of a home, no longer becomes a fixation but instead just another part of your growing portfolio.

The allocation of assets, albeit crudely in the case of offsetting rising property values with shares, is one of the keys to building wealth over the long term. So, if property prices rise, it is important to adjust the mix of assets you own by investing more in assets other than property. This means investing not only in shares but also in bonds and cash. In other words, it is important that you have a well diversified portfolio.

One thing to bear in mind is that asset allocation will not maximise your returns. But it should do the next best thing. It will reduce the risk to your wealth. In a nutshell, living modestly, overpaying your mortgage and having a properly diversified portfolio will enable most of us to ride out market downturns. And any paper losses you may incur from time to time will not affect your life too much because you are not losing actual cash!

- David Kuo is director at The Motley Fool. The opinions expressed are his own.-

BT’s annual results were expected to be bad. It turns out that they weren’t just bad – they were awful.

Now, many of us were expecting massive losses, a slashing of dividends, the axing of jobs and a gaping hole in the company’s pension fund. And BT duly delivered on all fronts.

Thanks to a dreadful year from BT Global Services (which handles network services for large businesses), the company announced an annual loss of 134 million pounds after having taken a painful 1.3 billion pound write-down from that unit (a big chunk of which was due to a single IT contract with the NHS).  So they’ve taken the losses on the chin and got rid of the bosses.

Meanwhile, BT’s dividend has been at the forefront of many investors’ minds, with the company having enjoyed an enviable track record of steadily rising dividends since its crisis year of 2001. But fears were today realised with a near 60 percent cut. The full-year dividend has been slashed from last year’s 15.8 pence to just 6.5 pence.

Over in the pensions department, it’s been a dreadful year too. This past year has seen its fund reduced from a 2 billion pound net surplus last year to a 2.9 billion pound deficit this year - 2.9 billion pounds is a hefty hole to fill, and BT is planning to increase its pension fund contributions to 525 million pounds a year over the next three years.

Finally, with 15,000 jobs having already been lost in the 2008-09 year, a further 10,000 redundancies were expected to be announced for the coming year. But the jobs picture has turned out worse than that, with 15,000 now expected to go. BT hopes that most of those will go through natural wastage and voluntary redundancies, and that no compulsory redundancies will be needed.

Truth is, BT needs to improve productivity significantly if it is to compete in a global telecoms market. Currently, revenue in the global telecom sector is around 260,000 pounds for every full-time employee. But BT is some 30 percent less productive – its employees generate just 185,000 pounds per year.

Vodafone, on the other hand, boasts one of the highest levels of productivity. Its full-time workforce generates almost 500,000 pounds per employee or twice the industry average. Vodafone’s workforce also generates almost three times more revenue per worker than a comparable BT worker.

Of course BT’s low productivity is an unfortunate feature of its history as a denationalised monopoly. And although direct comparisons between, say, Vodafone and BT are difficult because one is mobile telecom business and the other fixed line, investors should nevertheless take this into account.

Private investors should consider efficiency and productivity of businesses when making long-term investment decisions. Lower productivity can translate to lower long-run returns for shareholders.

When investing in shares we tend to find that a rising tide may lift all boats, but a financial hurricane can sink many ships. BT has benefited from a rising financial tide, but its low productivity has now been found wanting.

- David Kuo is director at The Motley Fool. The opinions expressed are his own. -

The Bank of England Monetary Policy Committee decided to leave interest rates unchanged at 0.5 percent in May. This came as no great surprise given that the Central Bank has already slashed interest rates to a level where further cuts would have made no discernible difference to the cost of money.

That said, there are other ways to drive down the cost of money. In this regard, the Central Bank still has plenty of gunpowder left in its keg to blast the UK economy out of the doldrums. So far, it has only printed two-thirds of the 75 billion pounds of fresh money authorised by the Government for quantitative easing. It can pump in another 75 billion pounds into the economy after that. So, in total, it has 150 billion pounds in its armoury.

It can be argued that the Bank now has little choice but to continue pumping money into credit markets through quantitative easing given that cutting interest rates has not worked. After all, the problem that that UK faces is not the cost of money but instead the quantity of money.

Curiously, pumping 50 billion pounds into the credit markets has yet to have an effect on broad money growth. But at some point quantitative easing will increase money supply. However, it will come at a heavy price – inflation.

Of course inflation appears to be subdued at the moment, though this depends on which inflation index is used to measure the rise in the cost of living. The Retail Prices Index (RPI) has fallen to zero but the Consumer Prices Index (CPI) rose from 3 percent to 3.2 percent. The latter, which excludes mortgage costs, suggests that the cost of living is still going up at a time when consumers have little appetite to spend money.

The danger for consumers is that when Quantitative Easing begins to work, the surge of money and credit into the economy could boost inflation significantly. It is therefore vital that savers ensure they are properly invested in assets that keep pace with inflation.

– David Kuo is a director at the financial Web site The Motley Fool. The views expressed are his own. –

The 2009 Budget could be the toughest that any Chancellor will ever have to produce. There is a gaping hole in the country’s finances. Alistair Darling, as custodian of the country’s cheque book, has to find a way to plug it. Not bridge it, not tiptoe around it, not spin across it, but to close it before it gets bigger.

Now, anyone who has ever been responsible for a budget will know that shortfalls eventually need to be filled. In the case of the UK’s finances, there is a forecast deficit of 77 billion pounds for 2008/09. The deficit projections for the following three years are even higher.

THE STORY SO FAR

Of course occasional fiscal deficits are tolerable. But an accumulation of annual deficits, in other words our national debt, is a different matter. In Britain, including the recent banking bailouts, it’s 717 billion pounds which is 49 percent of our gross domestic product.

But that’s not all. The UK economy, which was originally only expected to contract around 1.5 percent over the course of this year, is now forecast to shrink by more. That means even less tax revenues to pay for the Government’s planned expenditure. By 2012, the debt could rise from its current level to well over 1,000 billion pounds. Does the Chancellor grit his teeth and hope the gilt market can bear the additional debt or does he take decisive action to cut the projected shortfalls over the next three years?

WHAT WILL THE CHANCELLOR DO?

Of course, Alistair Darling can’t rely on economic growth to boost tax receipts. In normal times, he could cut spending or raise taxes to plug a shortfall. In the current economic climate though, both of these will harm an already fragile economy.

Of the two, targeted tax rises seems the most likely option. The only three taxes that bring in enough revenue to make any serious impact on the budget deficit are income tax, national insurance and VAT.

The Chancellor has already announced the introduction of a 45 percent tax band during the next parliament for people earning more than 150,000 pounds a year. But he could bring this forward - and it could affect 400,000 to 500,000 people!

The new 45p in the pound tax band is estimated to raise around 1.2 billion pounds. As you can see, this is small beer compared to our national debt. Could the Chancellor go one step further? He could introduce a 50 percent tax band for those earning more than 100,000 pounds a year, or announce another increase in National Insurance. VAT was cut to 15 percent at the end of last year but we could see it rise to 20 percent rather than reverting to its previous rate of 17.5 percent.

GOOD NEWS FOR SAVERS

The Government has already said it would like to do something for savers, who have seen their interest rates slashed in recent months. So we could see an increase in ISA allowances, particularly for the cash element of this scheme. We may also see greater flexibility between switching from shares into cash within the ISA wrapper.

CAR SCRAPPAGE SCHEME

A car scrappage scheme to boost flagging carmakers has been widely tipped to be a headline grabber in this year’s Budget. Through the scheme, the Government could offer car owners up to 2,000 pounds towards the cost of a new greener model. The danger with such a scheme is that it would appear to be a bail-out for carmakers at the expense of other industries, and at a time when cutbacks on spending should be the order of the day.

The 2009 Budget could be the best time or the worst time for the Chancellor. It depends on whether he wants to get the country’s finances on the straight and narrow as soon as practically possible, or whether he has both eyes on the next election. We’ll find out on April 22.