What does the latest interest rate hike mean for investors?
NOPE surprises for everyone today as the Bank of England raised interest rates by 0.5%. The last time rates were raised this much all at once was in 1995. At the time of writing, yields on two-year gilts (1.8%) and the pound (1. 21 against the dollar) were little changed that day.1.
Today, the Bank reaffirmed that it expects inflationary pressures to dissipate over time and that “commodity prices are not expected to rise further”. However, it also acknowledged that there remained “exceptionally significant” risks to its forecast, due to both external and domestic factors.2.
At 1.75%, the bank rate remains paltry compared to inflation approaching 10%, which suggests that the Bank is content to watch the markets and the economics of supply and demand do well. part of the job when it comes to fighting inflation.
The last time inflation was as high as it is today – in early 1982 – interest rates were around 14% although, admittedly, general economic conditions were very different than today. ‘today.3.
The markets, on the other hand, seem to be signaling that the Bank has already – or is about to – go too far. Gilt yields are now broadly similar for two- to ten-year maturities, consistent with a stagnant economy and inflation returning to trend4.
In any case, interest rates are a rather blunt instrument given the current economic circumstances. International commodity prices, coupled with disrupted global supply chains post-pandemic, are largely beyond the Bank’s control.
In the worst case, higher interest rates push the economy into a recession without having a significant effect on prices.
The risk of a recession in the UK is heightened by the economy’s heavy dependence on consumer spending. Anything that influences the consumer’s ability or propensity to spend also affects expectations of economic growth.
This makes raising interest rates a dangerous game. There are already signs of a consumer strike, with a drop in sales of white goods and household goods and a shift to cheaper brands underway5.
Meanwhile, soaring mortgage interest costs appear to be finally wiping the foam from the housing market. UK house prices rose a meager 0.1% last month6.
Falling house prices could trigger a negative “wealth effect”, leading to a further drop in consumption.
We live in a time of volatile expectations. Views diverge wildly on the direction the economy will take, with talk of even higher inflation, a soft landing for the economy and even the possibility of a period of deflation if rates rise too high. All of these scenarios seem possible.
In these uncertain times, it makes sense for investors to keep a cool head and a diversified portfolio of investments to help them stay on track towards achieving their long-term goals.
1 Bloomberg, 04.08.22
2 Bank of England, 04.08.22
3 Bank of England, August 2022
4 Bloomberg, 04.08.22
5 British Retail Consortium, 12.07.22
6 National Construction Company, 03.08.22