Interest rates go up to 0.5%.

The Monetary Policy Committee has voted by a majority of 7-2 to increase the Bank Rate by 0.25% to 0.50% - the first rise for 10 years. But what does it mean for investors?

Interest rates go up to 0.5%.

The Committee voted unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases, financed by the issuance of central bank reserves, at £10bn.  The Committee also voted unanimously to maintain the stock of UK government bond purchases, financed by the issuance of central bank reserves, at £435bn.

The move was expected said Neil Williams, group chief economist at Hermes Investment Management.

“Today’s quarter-point rate hike shouldn’t raise eyebrows, and looks for now to be a one-off ‘muscle flex’ by the BoE, rather than the start of an aggressive tightening,” he said.

“What it does is reverse the post-referendum cut from 15 months ago which, with activity broadly holding up, may have been an unnecessary safety-net. In the MPC’s eyes, it also gives them more rate ‘powder’ to use, should the economy later start to slow again.

“But this is of course circular and the Bank will be mindful that raising rates too far does not cause that economic downturn!”

Williams believes that in the absence of a recovery in real wages – which have been squeezed for a decade – the Bank won’t hike aggressively. “Their hope is that productivity begins to lift from 2018, justifying higher wage claims. If it does, they could admittedly then get twitchy fingers.”

Azad Zangana, Schroders senior European economist, agrees that despite a sluggish economy, the central bank is worried about rising inflationary pressures.

Inflationary pressures

“Since the Brexit referendum, the UK economy has performed better than expected, while inflation has risen sharply, largely due to the depreciation in sterling,” Zangana said.

“With inflation just shy of 3.1%, if it rises further, then the BoE may have to write to the Chancellor of the Exchequer to explain the circumstances of the overshoot, and what it is doing to return inflation back to target.

“While many are asking whether this interest rate rise will have much of a negative impact on growth, the more important question is whether the MPC sees this as a one-off rise, or whether this is the first of many.”

Brexit is key

Further rate hikes depend on Brexit, Ian Kernohan, economist at Royal London Asset Management, believes.

The Bank was keen to stress that any future increases will be limited, and subject to developments related to the process of EU withdrawal,” he said.

“At 0.5%, the base rate will still be at an extremely low level, having being held at this level for most of the period since the financial crisis.  On the other hand, many borrowers will never have experienced a rate rise, so there will be some element of surprise.

“As long as interest rates rise very gradually from here, then with around 60% of mortgages on fixed-rate deals, the impact on household finances shouldn’t be too severe, and will be offset by any future fall in inflation.

“We assume that the MPC will raise rates slowly over the next two years, assuming a Brexit deal is visible by mid-2018, unemployment remains low and global growth holds up.  With inflation set to fall next year as the impact of sterling devaluation wanes, the MPC will stop hiking if there are clear signs that the economy is slowing.”

Trevor Greetham, head of multi asset at Royal London Asset Management, added: “It’s not often you can say that interest rates doubled today. Rate hikes are never popular with borrowers, but with base rates at only 0.5% and inflation at 3% there will be little pushback.

“As the Bank made clear in their statement, Brexit is still the elephant in the room and there are considerable risks to the economic outlook and to sterling, which sold off in the aftermath of the announcement.

“Nearly eighteen months on from the referendum, all options remain plausible. It’s hard to imagine a continued tightening of monetary policy in a disruptive no deal outcome, and in this scenario sterling could easily fall another 10 to 15%.

“On the other hand, if permanent single market membership becomes likely, or if we see a reversal of the decision to leave the EU, the Bank of England would be comfortable raising rates further. In this case, sterling would probably rise 10 to 15%.

“Rarely have investors and business decision makers seen such exchange rate uncertainty, with a 20-30% range for where the pound could be in 2 to 3 years’ time, dependant on closed-door discussions between politicians.

“In our view, UK investors with a low appetite for risk should ensure the bulk of their investments are sterling denominated. Doing this should help to remove one particular source of uncertainty from the equation.”

 

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