The Bank of England Monetary Policy Committee has voted 7 to 2 to raise Bank base rate to 0.5% from 0.25%. This is the first time the Committee has raised interest rates in a decade.
While the move is historically significant, the rise is simply reversing the rate cut of last year following the Brexit referendum. Last September, the Committee cut rates from 0.5% to 0.25% in a bid to restore stability as sterling fell and the UK's economic outlook was downgraded after the UK voted to leave the European Union.
Prior to that, rates had been at 0.5% since March 2009 in reaction to the global financial crisis and subsequent UK recession. Just one year earlier, in March 2008, base rate sat at 5.25%.
For the last three months, two policy members have voted to raise interest rates to 0.5%, as inflation concerns have risen, unemployment remains at record lows, and the UK economy continues to grow – albeit at a rate slower than other developed markets.
Experts expect this rise to be the first of many – but at a slow and steady pace. Chris Beauchamp, chief market analyst at online trading platform IG, says: “Given the rally in pound against the dollar over the past few days, it is clear that a rate increase is not the event that will spark volatility. That honour belongs to the statement and minutes, as we spend the hours following the midday decision trying to work out whether this is just a one-off or the beginning of something more.”
Sven Balzer, senior strategy manager at Coutts commented that rising interest rates are good for financial stocks, as well as bonds.
“We expect inflation to tail off in the coming months as the effect of weak sterling drops out of the data,” he said. “Given this, and the as yet unknown potential economic effects of Brexit, UK interest rates are likely to remain low and the timing of the next rise is uncertain. However, falling inflation will ease the pressure in real incomes, leaving consumers better able to manage any rate rises in the future.”
What Does this Mean for Markets?
The impact on bond markets has been limited, as this rate rise was widely expected. The 10-year gilt yield jumped in September as Bank Governor Mark Carney indicated that consumers could expect a rate rise before the end of the year. It now sits at 1.35%, up from 0.97% in early September. The FTSE 100 is flat to 7,513 in mid-day trading.
Henderson fund manager Ben Lofthouse has debunked theory that rising interest rates are bad for equities. Many consider a more attractive bond market – with real inflation beating yields – to mean bad news for equity markets, as investors sell up their stocks in favour of the less risky asset.
But Lofthouse, who manages the Henderson International Income Trust (HINC), says historical data proves otherwise. In seven of the last eight rising rate environments, developed market equities rallied. In December 1986 to September 1987, the 10-year gilt yield rose 236 percentage points and developed markets rose on average 26.8%, in 1999 the 10-year gilt yield rose 158 percentage points and equities were up 26.9%. More recently, from May 2012 to December 2013, the 10-year gilt yield rose 140 percentage points and markets rose 38.2%.
Fed Holds Rates – but Not for Long
Yesterday, the Federal Reserve voted to hold rates in the US at between 1% and 1.25% but signalled it may hike rates in December. The Fed has raised its benchmark interest rate twice this year in March and June, and once the previous year December 2016.
Lee Ferridge, head of multi-asset strategy for North America at State Street Global Markets says that the market is predicting an 80% likelihood of a December hike.
“Even though the most recent core inflation reading for September, released on Monday, remained significantly below the Fed’s two percent target at 1.3%, the Federal Open Market Committee continues to focus on the low level of unemployment and its expectation that this will eventually lead to wage inflation. It would take a major deterioration in the data – possibly starting with Friday’s labour market report – to deter the Fed from tightening in December.”
