Yesterday (08/02/2018), the Bank of England (BoE) warned that the pace of interest rates will increase sooner than expected, if the UK’s economy continues to grow quicker than expected, with a 0.5 percent rise in the last three months of 2017.
Despite, the Bank of England voting to keep interest rates on hold this month, the “prospect of a May rise is firmly on the table,” according to Andrew Morgan, portfolio manager of Alpha:r² at Walker Crips.
“Although interest rate rises are often unwelcome news for equity investors – particularly in a country which relies on the consumer for much of its economic growth - they are also a sign that the economy is doing well. Along with rising interest rate expectations, the Bank of England has upgraded its UK growth forecast to a healthy 1.8 percent,” said Mr Morgan.
As forecasted by the National Institute of Economic and Social Research (NIESR) this economic growth is due to the strong global performance and the weak pound which will help increase GDP growth by almost two percent this year and next.
Mr Morgan describes this interest rise alert as being “unexpected” as “the Bank of England has been adept at guiding investors' rate expectations: as a consequence, markets took the autumn rate hike in its stride.”
Therefore no “major changes to our asset allocation need to be made and we therefore remain underweight fixed income assets, and remain short duration. We continue to be relatively defensively positioned in equities, despite the recent dip, and are looking at certain sectors - such as Financials - which tend to benefit from a rising interest rate environment."
Equally, Mr Morgan says that the company will look out for companies relying on overseas earnings, as “rising interest rates could cause the pound to strengthen further from here.”
Similarly, Ben Brettell, senior economist at Hargreaves Lansdown, said he was “fully expected” of the rise in interest rates, as the “Bank raised borrowing costs for the first time in a decade in November.”
“However, the Bank upgraded its forecast for the UK economy slightly today, citing stronger global conditions. It now expects 1.8 percent growth this year, as against 1.6 percent forecast in November. Policymakers also said they will try and bring inflation back to their two percent target more quickly than previously, which means rates could rise faster and further than investors had expected. The Bank’s rhetoric echoed that of September’s meeting minutes, which preceded the November rate hike.”
The expectation of higher interest rates has led to the rise in “gilt yields, while the FTSE 100 extended the day’s modest losses,” Mr Brettell continues. However, investors worry that “faster growth and higher inflation could prompt central banks across the globe to tighten monetary policy more aggressively.” These worries have led stock markets to a “sharp sell-off” this week.
However despite predictions from the Bank, economists still remain uncertain due to Brexit, which is why Mr Brettell thinks future decisions on interest rates will “depend heavily on progress in negotiations with the EU.”
Guy Foster, head of research, Brewin Dolphin said: “The Bank of England voted unanimously to leave interest rates unchanged, but they were talking tough on inflation. The bank referenced spare capacity specifically, so while demand has not weakened as much as they previously feared, the lack of UK investment and reduced labour supply will constrain capacity in the future. That means investors should expect three interest rate increases over the next two years with the first coinciding with May’s inflation report.”
“They had taken the emergency measure of allowing inflation to creep above target over their two-year forecasting window because they felt it would be necessary to support growth. Now they want to bring inflation back to target within two years, which implies faster tightening than had been warranted in November,” Mr Foster continues.
So in some ways this is good news as interest rates need to go up quickly as the Bank expects the economy to grow faster than expected. Also, in relation to the Bank’s hint of inflation the value of the pound increased by one percent against the Dollar and the Euro.
However, this could also be bad news as according to the Monetary Policy Committee, this growth is due to the global economy rather than anything being produced at home.