The Bank of England raised interest rates this month in recognition of the fact that the economy has not collapsed while inflation has picked up a little. The question now is does this signal the start of a rate hiking sequence such as the one the United States has embarked on? Alternatively, is it just a one off adjustment – a so-called “one and done”?
The tone of the accompanying statement suggested that the base rate would most likely rise slowly and gradually from here.
What will the market make of this latest change?
The prospect of this interest rate hike has been building steadily since September such that it would now have been a bigger surprise if it had not taken place. The market therefore only needs to react to the comments which Mark Carney made at the press conference. Whilst these might have been a little more tilted towards further rate hikes than some expected, it remains the case that the market only expects interest rates to reach 1% within the next two years.
Where will interest rates go next?
The accompanying statement said rates would rise in line with current market expectations, which are that the base rate will hit 1% by the end of 2020. That means there will be only two more quarter-point rate increases by then, although the statement stressed this was subject to revision as the economy moves through the difficult Brexit transition period.
What does this mean for investments?
This movement in interest rates had been anticipated so it will have little immediate impact. It is a positive for banks and general insurance companies which will benefit from higher rates received on reserves and short-term investments respectively.
Generally higher interest rates make shares less attractive, but the difference between stocks yielding 3-4% and cash at just 0.5% remains historically very wide. Investors are faced with the dilemma between saving in a way that provides an expected return that is comfortably above or far below current or forecast rates of inflation.
Interest rates can affect the pound as well. The recent anticipation of this rate hike has been good for the pound which has helped companies which buy goods and materials from overseas to sell in the UK. This includes lots of retailers. Conversely companies which sell most of their goods overseas have suffered. However, the pound fell after the announcement because of the suggestion by the Bank that rates will only rise very gradually.
What about borrowers?
The real impact on borrowers will be limited. Holders of repayment tracker mortgages will see modest increases. Generally the rates available on fixed rate mortgages have dropped below those available on trackers, leading consumers to shift overwhelmingly into fixed rate loans. That means it won’t affect too many consumers very severely.
The Bank of England monitors effective interest rates (the rates which consumers are charged). In 2010 the effective five-year fixed rate mortgage cost 5.7%. It has declined steadily since then and last month reached just 1.9%. This has provided a boost to the disposable incomes of consumers who could remortgage to take advantage of the lower rates. This has obviously also helped people to buy houses. Now it seems likely that such mortgage rates may be reaching their nadir. Added to which the loss of momentum for house prices nationally, and more specifically house price falls in London, mean that UK consumers may feel poorer or have less recourse to borrowing against their homes than they did in the past.
What will the impact be on the economy?
Generally, the economy is in mixed shape. Consumption has held up reasonably well considering that consumer prices have been rising faster than wages since the Brexit vote. Despite uncertainty over future trading conditions the manufacturing sector continues to benefit from better economic performance in our principal export market, Europe, aided by the weaker pound. Construction activity has, however, been very weak suggesting an unwillingness of companies to make further investment while uncertainty lingers. We saw a slight and unexpected improvement in an important gauge of construction activity today but it was driven by house building rather than commercial investment.
Guy Foster, Head of Research
Guy leads Brewin Dolphin’s Research team ensuring that a rigorous and exhaustive investment process is employed. He also provides recommendations on tactical investment strategy to Brewin Dolphin’s investment managers and strategic recommendations to the group’s Asset Allocation Committee. Before joining Brewin Dolphin in 2006, Guy was an Investment Director at Hill Martin (Asset Management). Guy has a Masters in Finance from London Business School. He is also a CFA charterholder, holds the CISI Diploma, and is a member of the Society of Business Economists. Guy frequently discusses financial issues with the written and televised media as well as presenting to the staff and clients of Brewin Dolphin.
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