Matt Tucker, Investment analyst at Quantum, gives his thoughts on the recent decision by the Bank of England to raise interest rates, and the possible implications this brings…
Matt said: Despite voting 7-2 to maintain the base rate at 0.25% during its September meeting, the Monetary Policy Committee has, as expected, now raised interest rates from 0.25% to 0.5%.
The dichotomy between weak growth and elevated inflation provided a dilemma for policy makers at the Bank of England – whether to raise interest rates in order to bring inflation down towards its 2% target, or to maintain its former accommodative stance to help stimulate growth. Initial estimates suggest the UK economy grew 0.4% during the third quarter, following growth of 0.3% during the second and 0.2% during the first, considerably slower than the upgraded Q4 2016 figure of 0.7%.
Key points
- The Bank of England chose to raise interest rates early in November.
- Newly issued bonds will offer investors a higher return.
- The implications for equities are likely to be negative.
The case for an interest rate rise was very much premised on the assumption that the output gap, which represents the difference between current output and potential output, is now smaller, with spare capacity within the economy being absorbed quicker than anticipated.
An unemployment level of 4.3% in the three months leading up to July has been suggested as evidence of this with some economists believing that this level is at, or indeed below, the natural equilibrium level of full employment.
Inflation remains heightened; CPI rose to 3.0% during September, well above its target of 2.0% and just below the level at which the Governor of the Bank of England has to write an open letter to the Chancellor explaining why the level has deviated from its target.
This is likely to remain elevated going forward; the Bank of England, as set out in the August Inflation Report, has forecast that CPI will remain above the 2% target up to mid-2020, as currency-induced cost pressures continue to exert their influence on the price level.
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