Interest rates: a significant turning point
Today’s interest rate rise may be small but it is highly symbolic – the first rise since 5 July 2007.
If there was a mechanism in place for interest rates to find a natural equilibrium my guess is that they would settle at about 3% – still some way off.
So this is not the end of the Bank of England artificially supressing interest rates. It is not even the beginning of the end, but it is, perhaps, the end of the beginning.
When Churchill came up with that line after the Battle of Alamein in November 1942 it was to be another three years before his dreams of war ending were finally fulfilled.
I wouldn’t be surprised if it took another three years for interest rates to reach anything like 3%. We may be in for a series of gentle increases now, interspersed over many months. Today’s rise simply takes us back to where we were before the Brexit shock.
It is welcome news though. It means the UK economy is in recovery – despite the threat of an unsatisfactory Brexit deal hanging over it.
We are seeing it in the company meetings we hold – reports of strengthening order books and rising wage demands – and this is reflected in the national data too.
But ‘strengthening’ is not necessarily ‘strong’. Inflation is picking up, which is to be welcomed as it will deflate the debt, but inflation, currently at 3% as measured by the Consumer Price Index, is in part due to the plunge in sterling after the referendum result – a spike that will fall out of the numbers in the coming months.
So it is not time to break out the party hats and tear up the ration books!
What impact it will have on investments and markets is harder to suggest. Perhaps very little at this stage. Rate-sensitive stocks like banks, insurance companies and property may see an uptick. For banks higher interest rates give them room for higher margins between what they charge borrowers and what they pay savers (providing the Chancellor does not force them to pass on any interest rate rise benefits in full).
Bonds could fall. Their position has looked precarious for some time with some yields below inflation meaning many investors, in real terms, are actually paying to lend. That cannot go on and though this is not necessarily the event to prick the bond bubble, it is surely coming.
As for sterling – it should benefit marginally. That might have a small negative impact on FTSE large cap stocks that have done well on post-Brexit currency falls, but the impact is likely to be marginal.
I come back to the conclusion that this is symbolic. For borrowers it is a warning that the tide is turning and more rises are on the way. Now is arguably the time to be paying down debt as hard as possible.
Savers will still have to wait some time before cash becomes anything but an unappealing necessity in the investment mix.
For shareholders it is a sign that the economy is stronger than it feels and that they need not be so anxious that the bull market is about to come crashing to an end quite yet.
Posted 2 November 2017
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