Thursday could be a hugely symbolic day if the Bank of England decides to raise interest rates above 0.5 percent for the first time since the financial crisis. However it doesn’t actually change too much on the ground. Markets are already expecting a rise, and from here on in, further hikes are going to be few and far between because UK economic growth is so fragile. Contributor Laith Khalaf Senior Analyst – Hargreaves Lansdown.
We could see some reaction from sterling though, which has remained resolutely weak against the dollar, despite rising expectations of a rate rise. That probably reflects the fact that economic data hasn’t been resoundingly positive in the lead up to this interest rate decision, plus of course the prospect of a no-deal Brexit has raised its head in recent weeks.
Investors will be wondering if this moment marks a turning point in markets where the trends we have seen assert themselves in the era of cheap money go into retreat. While rising interest rates do turn the tables on the winners and losers of last ten years, there are two very important caveats.
The first is that the journey upward is likely to be a slow grind indeed, so trends aren’t going to reverse overnight. The second is that the path to higher rates may undulate. Even though rates are very low and will remain so for the foreseeable future, they can still move down if there is an economic shock to the system. Few people thought rates would ever be cut from 0.5 percent, but that’s exactly what happened following the EU referendum result.
Maintaining a diversified portfolio is sound advice in any environment, because it can help protect you if things don’t turn out as planned. In today’s world of extraordinary monetary policy and political uncertainty, this looks like a particularly pertinent strategy.’
Swaps versus Sterling
The interest rates swaps market is sending very different signals from the currency markets about tomorrow’s interest rate decision . The swaps market is now pricing in a 91 percent chance of a rate rise, but Sterling appears nonplussed.
Economic data – what’s changed?
Across most key economic indicators the needle hasn’t significantly budged since the MPC last met in June (see below). Retail sales have been very volatile of late thanks to some pretty extreme weather and the Royal Wedding, so we shouldn’t set too much store by short term movements. Normally the Bank would have a preliminary reading of Q2 GDP from the ONS by now, but the statisticians have decided to push back publication of this estimate in the interests of greater accuracy. The ONS is now publishing a monthly update, though this covers just the period to May.
Which stocks and markets might be affected?
A rate rise wouldn’t be a surprise, so we shouldn’t expect too many jerky movements on the markets as a result. Longer term, some of the asset classes and sectors which have benefited from low interest rates may find things tougher going as monetary policy tightens, though they still provide useful diversification in the event of things not going according to the script.
Beneficiaries of lower interest rates
- Bonds – prices have risen thanks to loose monetary policy, but it’s hard to see much progress from here.
- ‘Bond proxies’ – solid growth stocks like Unilever and Reckitt Benckiser have seen investment from traditional bond investors as bond price have soared and yields have tumbled.
- Commercial property funds – as above, investors seeking yield and diversification in lieu of bonds might return to their natural habitat if bonds prices start to moderate to more attractive levels.
- Borrowers/ residential housing market/ housebuilding sector – higher mortgage costs could take some of the shine off the housing market and related stocks, though with rates set to rise so slowly, mortgage interest payments are likely to remain affordable for the foreseeable future. Those on interest-only tracker mortgages could see a sizeable jump though.
- Companies with high levels of debt – higher interest rates mean it will be more expensive to service borrowing.
Beneficiaries of higher interest rates
- Banks – can push through mortgage rises faster than cash savings rates, increasing their margin in the meantime.
- General insurers – should get a higher yield on the bond portfolios they use to back insurance products.
- Savers – will see some benefit, though it will be a slow grind, and the typical account still yields less than inflation.
- Companies with large pension deficits – in the topsy-turvy world of pension accounting, deficits fall as interest rates rise.
- Value strategies – growth companies have benefited from loose monetary policy because their future cash flows are worth more in a low interest rate environment. As interest rates rise, that effect subsides, and may lead to better relative performance from value strategies when compared to growth strategies.
What about currency movements?
Currency movements could also affect stock prices, though sterling’s performance will depend on more than just interest rates in the UK, not least it will factor in Brexit, interest rate expectations overseas, and perceived economic and political uncertainty.
However if rising interest rates do prompt a rise in the pound, this would be positive for supermarkets and retailers who would find stocking their shelves with overseas goods cheaper, providing some much needed relief on margins. It would also have a negative transnational effect on the sterling profits and dividends of some of the big beasts of the FTSE 100 like Shell and HSBC, who make much of their revenues overseas and declare dividends in dollars.
