The Bank of England (BoE) has announced a widely expected increase in the base rate from 0.25% to 0.50%, the first rise in over a decade, after the Bank’s Monetary Policy Committee voted 7-2 in favour of the hike.
The last BoE rate hike came in July 2007, when the base rate was increased to 5.75% on fears of inflation.
The Bank indicated that inflation, which hit 3% last month and is expected to rise further this month, would have remained well above the 2% target had the base rate been left at 0.25%, and that a further two rises would be necessary in the next two years to fully contain prices.
Market commentators from across the ETF industry shared their interpretations of the rate rise.
Alan Wilson, fixed income portfolio manager at State Street Global Advisors, the world’s third largest ETF issuer, commented: “From today’s release it is clear the MPC has run out of patience over the near-term horizon – the economy has performed in line with BoE forecasts, at the same time domestic inflation has accelerated to a five-year high, while the labour market has tightened below the committee’s non-accelerating inflation rate of unemployment (NAIRU) estimate.”
However, the guidance released alongside the rate decision was widely regarded as dovish, pointing to a slow process of monetary normalisation following the unprecedented action to stimulate the economy in the wake of the financial crisis.
Alexis Gray, economist, Investment Strategy Group at ETF giant Vanguard, said: “We expect that interest rate hikes will be very gradual, and the Bank of England will stand ready to reverse the rate hike if the economic outlook deteriorates.”
Nick Leung, research analyst in Europe at smart beta ETF specialists WisdomTree, commented: “We expect the BoE to adopt a dovish tone supporting gilts, allowing higher input-cost induced inflation to rein in consumer spending and de-lever household balance sheets. This allows the BoE to remain in accommodation mode and provide stability to the UK economy that will likely calm sentiment in UK risk assets, in particular small-caps that are vulnerable to Brexit.”
Some commentators took the view that this rise does not necessarily signal a series of future rate rises. “Despite today’s policy tightening, the accompanying BoE messaging suggests today’s hike was a one-and-done move; the MPC seem to be cognisant of the upcoming headwinds facing the UK over the coming year,” said SSGA’s Wilson.
While opinion on the timing of possible future hikes and the state of the UK economy remains divided, most commentators agree that it is inexorably linked to Brexit.
Among the more bearish voices was Wilson. “Questions remain over today’s policy announcement; survey data suggests the domestic economy is losing momentum, while inflation is set to peak as the effects of last year’s sterling depreciation fade,” he said.
Giovanni Dapra, Co-founder and Chief Executive Officer of ETF-based robo-advisor Moneyfarm, echoed the bearish sentiment. “Is this the right time to raise interest rates, though? UK productivity is low, GDP growth is patchy outside the services sector and the Brexit process gives no one any confidence. Will an increase in the cost of borrowing hamper UK company investment, damaging share returns? Will the UK consumer stop spending or default on loans? The UK economy has not dealt with ‘normal’ monetary policy for such a long time, it’s hard to believe it’s going to be a smooth ride to higher interest rates.”
However, there were plenty of optimistic voices. Vanguard’s Gray said, “In our view, investors should not fear the rise in interest rates as it a signal that the UK economy is recovering from the financial crisis.”
Mike Amey, Head of Sterling Portfolios at PIMCO, the manager of the £240m PIMCO Sterling Short Maturity Source UCITS ETF (QUID LN), pointed out rates could well rise faster than indicated by the BoE. “The market response to the UK rate hike has been relief that the Bank expects a very gradual hiking cycle. Using market expectations for an additional cumulative hike of 0.5% by mid-2020, the Bank sees CPI settling just above the 2% target. Conditioned on this forecast is a relatively smooth Brexit. We would agree that the most likely outcome is a relatively smooth Brexit, in which case the risks look to be skewed to a slightly faster path of interest rate hikes than those currently implied by the market.”
Risk assets seem to have taken the news positively, with the FTSE 100 ending the day up 0.90%, just shy of its record close set earlier this month. The share index’s gain, however, looks largely down to declines in sterling (down 1.4% against the dollar and 1.7% against the euro) on the back of the Bank’s dovish sentiment.