Market News

Market implications of the Bank of England interest rate rise

Our investment team analyse the outcome of yesterday's Bank of England meeting and what impact it will have on the markets.

03/11/2017

Alex Smitten

Alex Smitten

Head of Fixed Income

Richard Jeffrey

Richard Jeffrey

Chief Economist

Janet Mui

Janet Mui

Global Economist

As widely expected, the Bank of England (BoE) raised its benchmark interest rate by 0.25% to 0.5% in the November meeting, with a majority of 7-2 voting in favour. This is the first rate increase in the UK for over a decade (the last time rates rose, the iPhone had been very first released). The Monetary Policy Committee (MPC) voted unanimously to maintain the stock of sterling non-financial investment-grade corporate bond purchases at £10 billion and UK government bond purchases at £435 billion.

With regards to forward guidance, all members agreed that future increases in Bank Rate would be ‘limited’ and at a ‘gradual pace’.

With Consumer Price Index (CPI) inflation hitting 3% in September, UK economic activity remaining resilient and a continuing erosion of spare capacity, the inflation tolerance of the BoE has clearly declined. Indeed, the MPC judged that inflation is unlikely to return to 2%, at least until 2021, without some further adjustment in monetary policy. In our view, with the unemployment rate at a 42-year low (and generally strong labour market data), resilient household consumption, real earnings likely past its worst and a strengthening external backdrop, reversing the 0.25% rate cut last July is wholly justified and ought to be reinforced by further rate rises in the coming year. That said, the outcome of Brexit negotiations remains an important determinant of policy outlook and the BoE will remain highly data dependent.

The BoE’s GDP growth forecasts are little changed but the unemployment rate projection has been revised down meaningfully. The expected path for CPI inflation has been revised marginally lower, although the expected Q4 2017 peak has been revised up to 3.0% from 2.8%. As noted above, without further policy action, inflation is expected to remain above the 2% target at least until 2021.

Our view is that, although the rise in UK inflation is largely attributable to sterling weakness, there is a risk that second-round effects could be greater than expected. Moreover, there could be a weakening in inflation anchoring if households and companies begin to incorporate higher prevailing inflation rates into expectations – with those expectations then feeding through into wage demands and price-setting decisions.

The 0.25% increase in interest rates is unlikely to have a significant impact on economic activity. The economy is still generating growth in employment, household debt as a percentage of GDP has come down and many households will still be refinancing at lower mortgage rates. Also, the banking system and company balance sheets are generally in solid shape.

The markets reacted to the MPC removing the line “monetary policy could need to be tightened by a somewhat greater extent over the forecast period than current market expectations” from the previous minutes. 10-year gilt yields fell by more than 8 basis points and sterling weakened by around 1.5%, as the markets perceived this as a dovish interest rate hike.

 

 

Author

Alex Smitten

Alex Smitten

Head of Fixed Income

Alex Smitten joined in 2000 where he managed the Income Trust for Charities and the UK Corporate Bond Fund. Alex is now Head of Fixed Income and is a member of the Investment Policy Committee. Prior to joining Cazenove Capital, he was at Intercapital, where he set up the agency bond broking desk. Alex spent nine years at TSB/Hill Samuel where he was responsible for proprietary bond activity on behalf of the Group. Alex graduated from City University with a degree in Banking and International Finance. He has 29 years of investment experience.

Richard Jeffrey

Richard Jeffrey

Chief Economist

Richard Jeffrey is Chief Economist at Cazenove Capital and is responsible for the macro-economic framework that supports the investment process. He joined in 2008. Since completing a Master’s degree in Quantitative Economics, Richard has worked as a professional macroeconomist and market strategist. Richard has 37 years’ investment experience and appears frequently on radio and television and writes for a number of journals. He works with a number of think-tanks and academic organisations and currently sits on the Finance Committee of Bristol University.

  Richard Jeffrey
Janet Mui

Janet Mui

Global Economist

Janet is an Economist working in the Investment Strategy Team and a CFA charterholder. She joined in 2011 and previously worked in Citi Hong Kong as an analyst in Global Portfolio Management and subsequently as a relationship manager to multi-national clients. Janet graduated with a BSc in Economics from the London School of Economics (first class honours), holds an MBA in Finance from the University of Cambridge and obtained a Postgraduate Certificate in Econometrics from Birkbeck College, University of London.

  Janet Mui

The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital is part of the Schroder Group and a trading name of Schroder & Co. Limited 12 Moorgate, London, EC2R 6DA. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be taped and monitored. 

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