The markets and financial media are obsessed with interest rates these days.
Sometimes it seems that the daily casino yo-yoing of share prices is purely driven by comments from leading central bankers such as Mark Carney in the UK or Janet Yellen in the States.
So when Carney hinted last week that UK rates could rise sooner than expected perhaps in 2014 a new round of market chatter and speculation was triggered.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
But there's one point that hasn't had much coverage: rising rates could deliver a nice boost to one of the UK's largest companies BT (LSE: BT.A).
Will rates actually rise?
When Carney hinted that a rate rise would come soon, the price of shares and bonds went down a bit. Carney said yesterday that he was surprised at that reaction. But when people delved into the latest minutes of the Monetary Policy Committee (MPC) yesterday, it seemed that a rate rise should not be seen as a certainty this year.Some MPC members still think the economy has plenty of spare capacity, which means higher inflation is not likely to rear its ugly head. So bonds went back up again.
For what it's worth, I don't think interest rates are going up. There's certainly not much inflation about at the moment according to the official statistics. This is borne out too if you go to the supermarket, the petrol station or read your latest electricity bill. Prices are not going up much. In fact, lots of them are going down.
Rising interest rates have a silver lining
BT is certainly prospering at the moment. Its fibre optic broadband and move into televised sport is paying off. The company is generating shedloads of cash and is increasing dividends at 15% for the next couple of years. But there's one thing that worries even the bulls of BT shares its pension fund deficit.
Final salary pension funds are a very dry but important subject. The promise to pay employees a proportion of their final salaries in retirement is a wonderful deal for staff. But it can be a serious burden for employers.
At the end of March, BT's pension fund had a £7bn hole in it (it had assets of £40bn and liabilities of £47bn). If you are a shareholder, this pension fund hole is like a big lump of debt. More importantly, it has to be paid before you get your dividend. BT is paying an extra £295m a year into the fund for the next seven years to try and plug the hole. Big pension fund deficits mean lower share prices.
Final salary pension funds have been one of the biggest victims of low interest rates. That's because of the way companies have to account for these pension schemes. The promises to pay pensioners in the future have to be given a value in today's money.
That's done by a process called discounting'. Let's imagine that a pension fund's total liability in the future is £1bn. If we want to value that sum in today's money, we have to use a discount rate. So if all the liabilities crystallised in ten years' time they won't you'd discount the £1bn liability at 2% interest a year for ten years.
With such a low discount rate, the liability in today's money will be relatively large, but if the discount rate is 4%, the today's money liability will be smaller.
The discount rate is driven by interest rates, and as interest rates have been kept low, BT's pension fund hole has been getting bigger. That £7bn hole reduces the value of BT shares by 88p per share.
But if interest rates go up then the deficit in BT's pension fund could get smaller. For every 0.25% increase in interest rates, BT's liability goes down by £1.6bn, and its equity value increases by 20p per share. Yes, interest rates will affect the values of bonds in the pension fund, but probably not by as much to offset the reduction in the liability.
BT shares have been on a good run over the last few years but I think there's still more to go for. Some people may worry about it spending too much on televised football rights, but I think that risk is overplayed. Its fibre network gives it lots of advantages of Sky, while BT can make lots of money on broadband subscriptions with football. The shares are not desperately expensive on 13.4 times projected earnings and a growing dividend yieldof 3.2%.
And if you believe interest rates are going up, the pension fund provides another boost.
Our recommended articles for today
Investors beware: these are not benign times
What thousands of angry cabbies mean for your investments
-
The top stocks in the FTSE 100After a year of strong returns for the UK’s flagship index, which FTSE 100 stocks have posted the best performance in 2024?
-
A junior ISA could turn your child’s pocket money into thousands of poundsPersuading your child to put their pocket money in a junior ISA might be difficult, but the pennies could quickly grow into pounds – and teach them a valuable lesson about money
-
BT is making progress and the dividend is back – but is it time to buy yet?Analysis Investors in telecoms giant BT have seen dismal returns over the last 15 years. But there are signs that it is starting to turn things around, says Rupert Hargreaves. So should you buy BT shares?
-
Accounting scandal wipes 20% off BT’s sharesFeatures BT’s share price fell by almost 20% last Tuesday, after an update on an accounting scandal in its Italian business led to a profit warning.
-
Football’s £5bn bonanzaFeatures Competition between Sky and BT for rights to screen the footie has handed a £5bn windfall to the English Premier League. Can that really be a good deal? Simon Wilson reports.
-
Sell your telecoms shares – this merger madness is bound to end in misery
Opinion A lot of money will be spent in the telecoms tie-up frenzy – but much of it will be wasted, says Matthew Lynn.
-
A shake-up for the sleepy telecoms sector
Features The shape of the telecoms sector is changing, as BT's ambitious plans show.
-
Vodafone takes fight to BT
News Telecoms giant Vodafone has vowed to take on BT in the broadband and television market.
-
Company in the news: BT
Features BT is a company in rude health, but support for the share is waning, says Phil Oakley.
-
BT’s football coup
Features BT has made an aggressive move into the pay-TV sector, snatching lucrative football rights from Sky and ITV. But has it paid too high a price? Simon Wilson investigates.
