Today the base rate rose to its highest level since the financial crisis 10 years ago, with the Bank of England increasing it to 0.75%. All 9 members of the Monetary Policy Committee (MPC), chaired by Mark Carney, voted to raise the rate.
This was widely expected by both the market and commentators, given that the economic data published, for the second quarter of 2018 showed marked improvement on the first quarter.
In fact, it does bring into question when the MPC will consider the next one, given its previous comments on following a slow and steady path to future increases. However, it will continue to assess the underlying economic data going forward and the timing of such a hike will be dependent on this.
Some feel that an increase in interest rates is an unnecessary risk, given that while economic growth has picked up since the start of the year, it remains at a low level by historic standards.
The fall in unemployment has not led to higher inflation as might have been expected which would have possibly required an increase in interest rates in line with traditional ‘monetary policy’.
However, if inflation is above target but rates are low, this encourages excessive borrowing in the economy, which, possibly leads to a deeper financial crisis than that which occurs if rates are put up earlier and results in slower economic growth.
If markets think this is the first of a series of rate increases, then sterling should strengthen as more international money backs the pound.
This would possibly result in the FTSE 100 falling as it tends to flourish under a weaker pound.
As interest rates increase, bond yields would start to rise, which means capital values will fall. Again, this is good news if you are looking at allocating new money to bonds as your income should be higher. However, it could be bad news for many existing bond investors.
Also, it is worth considering ‘discount rates’ which is a mathematical equation that many in the city use to value companies. Basically, they look at the ‘risk-free’ rate of return, i.e. base rates or Gilts for example, and use it to help value a company. The lower the risk-free rate the higher value can be apportioned to a company.
So, if the risk-free rate rises, the potential value of a company falls. This is where the long-term view of rates is important and if the market thinks rates are going to increase a lot higher, share prices can start to fall.
Investment markets had already largely ‘priced in’ (accounted for) the rate rise (in stock prices), so the immediate reaction from markets was muted.
The biggest challenge facing our domestic market is Brexit. Markets don’t like uncertainty and indeed this has been reflected in noises from the business community in recent weeks, with some high-profile businesses voicing their opinions to our political leaders.
As the economy and markets adjust, it is expected that future rate rises will be gradual and limited.
Our Approach
As we have previously confirmed, we believe investors should remain focused on the medium to long term, investing over ‘time’, rather than trying to ‘time the market’.
We continue to assess the quality of any investment opportunities which come about as the result of our investment process and strict fund selection criteria. A long-term outlook when investing is clearly desirable, as short-term expectations can turn out to be unrealistic where events cannot be anticipated.
Active management remains important and generally volatility can be partially mitigated by diversifying investments across a broad range of asset classes that include equities, commercial property, fixed interest securities (bonds) and cash to spread risk even further.
For clarification of any points discussed above and any future independent advice regarding your own financial planning, please do contact us on 01626 833225 or email [email protected]
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