07 Aug 2018
By Paul Heath, Investment Manager, Blackadders Wealth Management www.blackadderswm.co.uk
Regular readers of this blog may begin to get the feeling that I have a problem with how newspapers present their facts. Admittedly, the declaration that interest rates in the UK are at their “highest for a decade” is wholly accurate. However, I feel the way this information is presented may gloss over the fact that we have moved only 25bps upwards to a base rate of 0.75% and I wonder if this is really enough to constitute the “End of ultra-cheap credit” comment. But, mostly I wonder whether the Bank of England was justified in raising rates by even this small amount?
Theoretically, the BoE is tasked with managing monetary policy in line with the Government’s inflation target of 2%, however, in practice, the Central Bank also consider wider economic factors when making their decisions - in particular growth and employment. While managing overall growth is not explicitly part of the BoE’s mandate (as it is with the Federal Reserve in the US) it would be foolish to forget to keep the car on the road because you were busy watching your speed.
After the decision; Governor Mark Carney commented that the strategy of cutting rates to support jobs growth had worked and it was now time to focus on taming inflation rather than supporting jobs growth. He feels that - with limited spare capacity - real wages are picking up while external price pressures are declining.
The Bank’s measure of inflation (CPI) is currently above target at 2.4% (June 2018), but the comments from the BoE don’t seem to address that this figure has (without any action on monetary policy) been declining since the tail end of last year when it hit 3.1% (Nov. 2017). The employment market is tight, but still, productivity is low, with many people in the UK suffering underemployment (think about the graduate barman at your local pub) or the weakening wage effects of new employment practices such as zero hour contracts or gig-economy jobs that don’t always equate to minimum wage.
The Bank appears to have made their decision more on the basis of forecast data, rather than hard backward looking data (and in this space, it is unfortunate but true to say that the BoE’s forecasts have always included a wide margin of error).
So why now?
So why then, do we think the Monetary Policy Committee has decided to act now, particularly in the extremely well-telegraphed way in which they have. I would draw you back to an interview Governor Carney gave in 2016 following the Brexit vote, when he had just cut rates to 0.25%. Over on the Continent and in Japan, Central Bankers were busy experimenting with negative interest rates (where savers effectively pay banks to hold their money) to which Carney commented that he “cannot see any scenario where I would consider negative interest rates.”
With such a categorical denial of the potential to cut rates below zero, and with a base rate of only 0.5% to begin with, one might suppose the BoE needed to raise rates a little so they had somewhere to cut to in the event that things get worse further down the road!
As ever, we cannot end without considering the impact on portfolios and our current positioning. Looking at the wider picture outside of the UK, we have been of the belief for some time that global interest rates are heading upwards. The US (which is in a much stronger position on Growth, Employment & Inflation) is leading the charge, but there are signs (such as the prescribed end to QE in the Eurozone) that on balance, most areas are tightening rather than loosening monetary policy. Fixed Interest is the area most exposed to interest rate risk – and as such we have held lower weightings in bonds and have preferred corporate debt (where higher income returns are on offer) ahead of sovereign debt. Going forward, we do not believe there is a great deal to fear as rates move upwards – Central Bankers around the world are looking for very gradual increases in rates. In his comments, Mr Carney guided towards a base rate of only 1.5% in 3 years’ time. It might be the beginning of the end for “ultra-cheap credit” but it doesn’t look like the end of “cheap credit”.
The content of this item is for information only. It does not constitute advice. Before investing in any financial product or service you should seek professional advice.