Fixed income markets correctly priced in a rise in interest rates last Thursday, as the Bank of England’s Monetary Policy Committee doubled the base rate to 0.5%.
That was nothing to get too excited about as the move had been well-telegraphed, with Governor Mark Carney having braced us for the probability since September.
Still, it’s the first time we’ve seen an upwards move in interest rates in more than a decade. But what are markets telling us will happen now?
Currently, one more 25 basis point raise for 2018 is being priced in, with a further hike of similar proportions set to follow the year after. That certainly tallies with what Carney indicated a week ago and would mean rates would be at 1% by the end of 2019.
It would be a brave person to bet against this happening, but many professional investors take a contrarian stance. Below, we outline the arguments for both scenarios:
Interest Rates Will Not Rise
Simon Blundell, head of BlackRock’s sterling bond portfolios, says he and Ben Edwards, manager of the Morningstar Bronze-rated BlackRock Corporate Bond fund, are more cautious. “We would suggest that there are many hurdles that the country has to overcome before we get further rate rises,” he says.
Blundell points out that the recent hike was only a reversal of the emergency cut implemented by the Bank after the Brexit vote. “Since then, the economy has not performed in the way they maybe feared and it’s given them comfort to take that cut.”
But fears over the UK economy persist, with Brexit uncertainty set to cloud the outlook for the foreseeable future. While Carney reckons “households are generally well-positioned for a rate increase”, Blundell suggests they may not be.
The main sticking point currently concerns real wage growth which, with inflation at 3% and wage inflation at 2.1%, is currently negative. “It’s very important for the Bank to start to see real wage growth come through to give them the conviction that they can continue in a rate rising environment,” Blundell explains.
“Lots of uncertainty which for us means the Bank is probably going to stay on hold until we get further clarity on some of those issues.”
Interest Rates Will Rise
Andrew Jackson, head of fixed income at Hermes Investment Management, says rates will definitely go up and that Blundell’s argument is very contrarian.
Jackson notes that it will be a global trend, not just confined to the UK. Clearly, the Federal Reserve is well into its tightening cycle, with a further move upwards expected in December. The European Central Bank may also begin to increase rates in the first quarter of 2019.
For the Bank of England, “it’s about having firepower”, says Jackson. If the economy weakens and interest rates are stuck at 0.5%, that leaves the Bank with “one arm tied behind its back”. With rates at 1%, they will “be up to a level where cutting can aid the economy”.
Clearly there are considerations to make – borrowers will continue to be the hardest hit, while those outside of London and the south east could also feel the pinch should those regions continue to lag – but the general direction seems to be up.
