UK rate rise set to shake up markets
Is it 'one and done' for the Bank of England or the start of a new tightening phase? The answer will have profound implications for stock and bond prices.
The rate rise was priced into stock and markets as a dead cert, though the 9-0 decision was slightly unexpected, with Ben Brettell, senior economist at Hargreaves Lansdown expecting two doves.
Looking further down the line, there are certain stocks and sectors that will benefit, and others that will lose out from higher interest rates. Russ Mould, investment director at AJ Bell, thinks the UK government bond market's reaction to the news will be key in shaping how the stock market responds.
"Certain sectors seem to perform well or badly depending on how the 10-year Gilt yield is doing," he explains. UK 10-year government bond yields have risen 12 basis points in the last month to 1.37 per cent amid expectations of gradual monetary tightening by the Bank of England.
Another impact from the Bank's decision today will come from the newly instated estimate of the long-term "equilibirum" interest rate, or R*. The Bank says this is between 0.75 per cent and 1 per cent currently, with a potential to be between between 2 per cent and 3 per cent if the economy is firing on all cylinders and Brexit uncertainty is discounted.
This neutral rate is important, according to Ben Yearsley, director at Shore Financial Planning, because it impacts the discount rate.
The discount rate is part of the mathematical equation many City analysts use to value companies. The lower the risk-free rate – the theoretical rate of return on an investment with zero risk like gilts – the higher value can be ascribed to a company.
"So if the risk-free rate rises, the potential value of a company falls," says Yearsley. "This is where the long-term view of rates is important, as if the market suddenly thinks rates are going to, say, 5 per cent - which they aren't – share prices will fall substantially."
Rate rises to be gradual and limited
The Bank of England said today that more interest rate rises would be needed to return inflation to target if the economy continues to recover at the current rate.
"Any future increases in Bank Rate are likely to be at a gradual pace and to a limited extent," the Bank said in its statement, adding that interest rates are unlikely to reach pre-financial crisis levels in the coming years.
Many commentators noted the importance of the Brexit negotiation process, which has so far been painful and protracted, in the Bank's thinking. Indeed, most of the questions at the press conference eventually returned to Brexit.
According to Neil Williams, senior economic adviser, Hermes Investment Management, the BoE's window for another rate rise will "become smaller in 2019 and even close by 2020", especially given the weakness of UK economic growth.
"To keep the lid on rates, the Bank could in tandem start to whittle away their QE stock," Williams adds. "Selling the assets is one for later to minimise the hit to the gilts market. However, as a first step, terminating the reinvestments would surely be the gentlest way of tightening policy. In effect, tightening by 'doing nothing'."
The likely path of interest rates will not be linear, says Jordan Hiscott, chief trader at Ayondo markets: "The recent economic data is not consistent enough to warrant a rate increase and future near-term increases. Brexit and the fractious nature of negotiations will likely also affect this determining of the next move for the MPC."
Karen Ward, JPM Asset Management's chief economist, EMEA, agrees. "Given the Brexit negotiations are likely to drag in to November it is unlikely the BoE hike again this year. But we expect at least two further 25bp hikes in 2019," she says.
David Brenchley is a reporter for Morningstar UK
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