The Bank of England today, as expected, increased base rates from 0.5% to 0.75%.
Personal investors have nothing to fear as Bank of England raise base rates to 0.75%
- Interest rate rises above 0.5% for first time since March 2009
- Sterling expected to rise a little in reaction which in turn will drive market a little lower
- Minimal impact expected for personal investors with market pricing in an expected rate rise since Bank of England backed off in May
Having backed away from an increase at the last minute in May following weak Q1 economic data, the Monetary Policy Committee (MPC) fulfilled the market’s expectations and increased rates for the first time since November 2017 and to a rate above 0.5% for the first time since March 2009.
This is a significant step on the path to the eventual normalisation of interest rates from the historic lows we have seen through the last decade. Notably, this is the first increase above the 0.5% level that base rates were cut to in March 2009 in the aftermath of the financial crisis.
The MPC has raised rates now as economic performance has improved and the Q1 data has appeared to be largely a weather related blip, but more particularly as employment has continued to be strong (unemployment reaching lows not seen since the mid-1970s) and real wages are now beginning to grow again. With the Government again in recent days signalling more generous public sector pay settlements and inflation still above target, the MPC will not want growing real wages to feed through into more stubbornly high inflation. This concern will have been compounded by last week’s data from the Office for National Statistics which showed consumer borrowing continuing apace and consumers spending more in 2017 than they earned – the first time that has happened in almost 30 years.
The increase in base rates will be welcome news for those with cash savings and anyone trying to drive an income from those cash savings. Although the increase may appear modest at just 0.25%, in reality, if you have a bank account paying interest at the base rate then the amount of interest income you will earn will increase by 50% as rates rise from 0.5% to 0.75%. The challenge is whether banks pass on the rate increase in full to savers. Many rates did not increase when base rates last rose in November 2017 and this latest increase comes just a week after the Financial Conduct Authority published a Discussion Paper (DP18/6) on savings rates in the cash market indicating its concern that long standing and inert savers were receiving poor rates. It went on to suggest that it would consider the introduction of a Basic Savings Rate for older accounts to help ensure a better return for savers. In light of that it will be worth watching the extent to which banks feel the need to visibly pass on the higher base rate to savers this time around.
For borrowers, the impact of the rate increase may be felt more quickly although many are now on fixed rates – with a significant proportion of new mortgage deals in recent times being taken out on a fixed rate basis.
For investors, a rate increase might be expected to temper any rises in equities and an asset value as cash is a more attractive asset and borrowing costs increase impacting company profits for those with debt. However, the experience in the US where rates have been increased six times in the last two years may give investors more reason to cheer as the Dow Jones Industrial Average Index has risen nearly 40% over the same period. This has been helped by strong growth and tax cuts but suggests that rising rates and a return to more normal economic conditions may actually be a positive for investors – not least in that they signal confirmation from the central bank as to the strength of the overall economy.
In the near term Sterling will likely rise a little and as a result, overseas earnings of many of the companies in the FTSE 100 may fall in Sterling terms and this might drive the market a little lower. However, in the UK the bigger concerns are uncertainty regarding the final Brexit arrangements and the volatile news flow from those discussions will likely have more impact. The market has been expecting a rate rise since the Bank of England backed off in May and has largely priced in this initial increase so there should be little impact for investors.
Longer term investors should consider which sectors and which companies may benefit from rising rates. Assuming a smooth Brexit is agreed then today’s increase should be considered the first step on a gradually rising path to rates around 2% (as they are now in the US). Companies who have cash balances, no or low debts and are in industries where behaviours are not particularly impacted by rising rates will do best.
Overall, I believe this is a welcome step on the path to more normal economic conditions and the significance of this being the first rise to take rates above the levels they were cut to nearly a decade ago following the financial crisis should not be overlooked.