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Prospect of interest rate rise sees pound jump

Written by: Adam Lewis
Intensifying inflation pressures led to a split of opinion from the Bank of England’s Monetary Policy Committee whether to raise interest rates.

Rather than the 7-1 split that had been expected to vote to keep the base rate at its record low of 0.25%, the MPC instead narrowly voted 5-3 in favour. However, the committee unanimously voted to continue with the programme of corporate bond purchases and UK government bond purchases.

The soon to be departing Kristin Forbes was joined by Ian McCafferty and Michael Saunders in calling for an immediate 0.25% base rate increase following the consumer price inflation figure jumping to 2.9% in May.

Set against a backdrop of disappointing retail sales, slowing growth, shrinking real wages and heightened political uncertainty, Hargreaves Landown’s senior economist, Ben Brettell, said the increased votes for a raise were “somewhat surprising”.

“It seems the willingness of the MPC to ‘look through’ higher inflation and leave rates on hold is wearing thin, and if inflation continues to surprise we could see higher rates by the end of the summer,” Brettell said. “The minutes show policymakers are more optimistic than many economists about the UK’s prospects.

“Despite the current weakness in wage growth, they see this picking up sharply over their forecast period, and also believe lacklustre consumer spending will be offset by a pickup in other components of demand – notably exports, which are being helped by the depreciation of sterling and stronger growth elsewhere in the world. The minutes made no mention of last week’s surprise election result.”

Sterling lifted but FTSE 100 kicked lower

Russ Mould, investment director at AJ Bell, said the pound was boosted on the news. He said: “Three members of the MPC voted for an increase in interest rates to 0.50%, compared to just one in the prior two months, while five voted for no change. That is the highest count in favour of tighter monetary policy since May 2011.

“The prospect of higher returns on cash is giving sterling a lift against the dollar (to nearly $1.2750) and euro (€1.1390), especially as markets had previously thought the Bank of England would only look to increase interest rates from their record-low levels after Brexit in 2019.”

However, the FTSE 100, which has seen a negative correlation with the value of the pound of late because of its large proportion of overseas earnings, fell by 30 points or so on the news.

Mould added: “This is hitting the ‘pound-down-FTSE-100-up’ trade which has dominated UK equities since the summer 2016 EU referendum. Miners in particular are falling hard, as their earnings are dollar denominated, although the more domestically oriented FTSE 250 is falling faster  still, with stocks exposed to discretionary consumer spending doing the worst, including Restaurant Group, Howden Joinery and Next. House builders are also being hit hard.”

Despite the inflationary pressures, Michael Allen, chief investment officer at Momentum UK, said the reality is that the MPC is likely to leave rates on hold to support the economy as we go into Brexit negotiations.

“Members may also be expecting that this period of high inflation will start to fade as year-on-year currency devaluation effects and increase in underlying energy prices roll out of the inflation basket,” he said.

“As such, anyone looking for a meaningful return on their money might want to look at low risk investment options which deliberately aim to generate returns in excess of inflation.”

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