The Bank of England cut UK interest rates on Thursday to 5%, the first cut in more than four years, but UK stock markets barely moved on the decision. So what does this mean for UK stocks generally and for sectors exposed to rate changes?
UK Stock Sectors in Focus:
• Housebuilders
• Hospitality and leisure
• Consumer Discretionary
• Banks
For Mike Coop, chief investment officer (EMEA) at Morningstar Investment Management, the BOE’s decision will be broadly supportive for domestic equities.
"It means that monetary policy will become relatively more stimulative which is good for equities," he tells Morningstar UK.
Some UK Stocks Are Less Rate Sensitive
Overseas earnings for the UK's largest companies complicate the outlook though.
"The UK stock market is driven 80% by earnings offshore. So, there is a weak link between UK interest rates and the earnings of the UK stock market. It is much more of a company specific question, and while there are some domestic plays its direct link with the UK stock market is not that strong."
Housing Stocks Anticipated the Cut
One obvious stock sector to benefit from expected and actual interest rate cuts is housing. Large listed housebuilders like Persimmon (PSN) have already risen in value this year on anticipated rate cuts, which make mortgages more affordable for consumers and lowers debt costs for companies. Falling inflation and an improving economy have also boosted the prospects for the key housing sector, with recent surveys showing a recovery in prices.
Laura Foll, portfolio manager at Janus Henderson, and manager of Henderson Opportunities Trust (HOT), Lowland Investment Company (LWI) and Janus Henderson UK Equity Income and Growth, believes that the UK’s housing sector will be one of the principal beneficiaries of the cut despite the modest reaction on Thursday.
"[The cut] means that people’s mortgage rates are likely to come down modestly, and that will probably stimulate demand again in a modest way. If you are a house builder and you are deciding what housing volumes to build you cannot suddenly just build more houses. You must put things in the pipeline," Foll says.
"If you see demand coming back in a more meaningful way you are probably more likely to accelerate those plans to build more houses. That then has a knock-on impact for the building material sector as well"
Abby Glennie, Abrdn’s deputy head of smaller companies and the lead manager of the Gold-Rated Abrdn UK Smaller Companies Institutional Income Fund, also believes that wider sector stocks away from the housebuilders will reap the rewards of the cut, backing estate agent Savills (SVS) and broker the Mortgage Advice Bureau (MAB1) .
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Despite the boost to property stocks, Glennie sees the interest rate cut as an additional welcome stimulant for UK equities, which had already posted record highs this year (see chart of the Morningstar UK index). For her it's "another tick in the box" for an improved outlook for domestic stocks, which include economic growth, a new government, M&A interest.
"We often get asked by clients: do you need interest rate cuts for UK markets to be positive? I think it's helpful, it is a catalyst, but it is not necessary. The UK markets can still do well without a rate cutting cycle."
"The best evidence of that is if you look at markets since October, small and mid-caps have been good in that period and not only did we not have rate cuts but expectations of those were pushed out."
Glennie points to attractive UK equity valuation levels, the improved economic cycle, M&A activity, as well as a change in government as factors that have contributed to a more positive outlook for UK stocks.
"The interest rate cutting cycle is another tick in the box. The political stability point has been a real negative in terms of the perception of the UK. But you can look at other regions in the world where you have political question marks and the UK looks more settled, and what the market tends to like is stability."
Focus on Consumer Stocks and Bond Proxies
For Hugh Gimber, global market strategist at J.P. Morgan Asset Management, the key rationale behind the interest rate is the progress the UK has made on inflation.
"With economic momentum picking up and consumer confidence rebounding as the cost of living crisis fades," he says.
Against this backdrop, Gimber believes that hospitality and leisure stocks will also be beneficiaries of lower rates, if consumers have more money in their pockets.
"However, if economic momentum starts to wane as we move later in the cutting cycle, equity market leadership will likely shift again, with more traditional 'bond proxy' sectors like utilities and consumer staples coming to the fore."
Kathleen Brooks, research director at XTB, believes that domestically focused stocks in the midcap FTSE 250 will see a boost.
"Most of that index is very leveraged to the real economy. We have seen increases in consumer discretionary stocks. Although the FTSE 250 is falling, the consumer discretionary sector is holding up as well as real estate. These are the two sectors most linked to interest rates," she says.
She points to the higher economic forecast from the Bank of England as evidence that the UK economy is recovering after falling into recession last year.
But Financial Stocks Could Struggle if Rates Fall
She also believes that a run of rate cuts could put financials in a tricky position. Barclays (BARC) was one of the fallers on Thursday, despite a strong share price performance in 2024 so far.
"We did see Barclays come out upgrading their estimate for net interest income, and that could be hit going forward by falling interest rates. The fact that the Bank of England revised down their rate expectations for the next two years is not great for the financial sector," Brooks says.
Lower interest rates reduce banks' net interest income, a key metric for the sector. UK bank stock prices have performed well this year as interest rate cuts have been deferred because of "sticky" inflation. Markets have recalibrated their expectation that rates will not fall back rapidly to pandemic levels but will be "higher for longer". This has supported financial stocks in the US, eurozone and UK, but could start to reverse as monetary policy gets looser.
