Could interest rates hit zero?

Not quite, say economists, but rates may fall further this year

INTEREST rates are falling but could they end up close to zero?

That was the startling situation posited in an analyst report last week - good news for mortgage holders but painful for those looking for some return on their bank deposits.

Thankfully, economists polled by The Straits Times say that the spectre of zero interest rates - seen most recently in Japan - is unlikely to occur in Singapore. But they warn rates will probably fall further this year to skirt the absolute baseline, before rising a little by year end.

The trend here is in stark contrast to the rest of Asia and Australia, where central banks are lifting rates, sometimes aggressively, to fight inflation.

Rates started falling here after the Monetary Authority of Singapore (MAS) decided last month to let the Singapore dollar rise against a basket of currencies.

The MAS had been intervening in the currency market up to that point to hold rates at the same level, and at the same time keep the Singdollar within its trading band.

Mr David Carbon, managing director for economic and currency research at DBS, has estimated that the MAS intervened to the tune of US$63 billion (S$86.9 billion), but it has now allowed the currency to appreciate and interest rates to adjust back to their actual levels.

The money market response to all this has been dramatic.

After hovering at 0.65 per cent for the past 14 months, the benchmark three-month Singapore Interbank Offer Rate (Sibor) fell 13 basis points to a new low of 0.52 per cent two weeks ago, before edging up slightly to 0.53 per cent. Sibor is the rate at which banks lend to each other and serves as a handy benchmark for all kinds of rates here, particularly mortgages.

Banks reacted to the falling Sibor by offering savings rates of a measly 0.1 to 0.2 per cent. Fixed deposits are marginally better at 0.4 to 0.6 per cent for a period of one to two years.

So a deposit of $10,000 for two years could earn you an annual interest of about $60: a few pizzas and a beer.

With such pitiful returns, investors have been looking elsewhere to put their cash. But mortgage holders are cheering as the falling Sibor means loans pinned to it have fallen as well, although some banks have raised the fixed amount that is added on to the base rate.

Others stuck in long-term mortgages are also looking to refinance for better rates, say financial planners.

'Sibor can't go to zero but it can take another step or two in that direction and seems likely to do so,' says Mr Carbon, who forecasts Sibor to bottom out at 0.43 per cent by the end of next month, and to start rising slowly to 0.61 per cent by the end of the year.

Economic issues unfolding across the globe, particularly in the United States, and the way Singapore responds mean low rates will continue for a while.

Unlike most other countries, Singapore's high dependence on exports and imports means the MAS controls monetary policy through its exchange rates. During high inflation, a stronger currency helps to make imports cheaper and so eases pressure from imported inflation.

Singapore's policy also means it tracks the interest rate policy of its major trading partners, including the US where rates are at rock bottom - between zero and 0.25 per cent.

So rates here 'are likely to remain depressed as long as US rates are low', wrote economists at Standard Chartered in a report on April 29. They expect Sibor to drop further to 0.5 per cent by the end of the second quarter and stay there for the rest of the year.

The huge Europe bailout package and continued scepticism over that region's ability to grow amid a burgeoning deficit has some analysts believing rate hikes in Asia may have to be delayed. But it may not derail a rise in the Federal Reserve's rates as economic indicators continue to point to an improving situation in the US.

That is prompting economists to tip Sibor to recover near the end of the year.

Barclays Capital economist Leong Wai Ho believes it will rise a little to 0.6 per cent by then, while OCBC economist Selena Ling sees rates rising to 0.8 per cent.

Financial advisers suggest savers could invest in mutual funds and unit trusts that are relatively low risk and have given higher returns of 2 to 3 per cent.

More sophisticated investors might try short-term bond funds, said Fundsupermart general manager Wong Sui Jau. While bonds can be seen as risky, he noted that only once in the past eight years - 2008 - did bond funds produce negative returns: 'Generally they are not volatile and are relatively low risk.'

Investors willing to take even more risk could try funds investing in Asia and emerging markets bonds.

'Currency appreciation in those countries is likely to be on a par with the Singdollar appreciation and would give a decent amount of yield,' Mr Wong said.

Source: Straits Times, 13 May 2010