Hawkish BoE hints at earlier rate rises

The Bank of England has held interest rates at 0.5% but hinted at quickening the pace of further increases to bring inflation back in line with its 2% target.

Advisers favour Vanguard Lifestrategy despite duration concerns

The bank’s Monetary Policy Committee (MPC) members voted unanimously to keep rates on hold, but said they would need to rise “somewhat earlier and by a somewhat greater extent” than previously outlined to prevent the economy overheating.

Interest rates were cut to exceptionally low levels following the financial crisis to support spending and reduce unemployment. But with the economy improving, the bank decided in November 2017 to raise the rate by 25 basis points to 0.5% – its first hike in a decade – to control inflation which was 3.1% (CPI) in November.

At the time it forecast two further increases over three years.

However, the MPC said since then the outlook for the UK economy has slightly improved with a falling pound and low unemployment and it is therefore predicting 1.8% growth this year against its November forecast of 1.6%.

It also expects inflation to remain at around December’s 3% level for a little while longer as robust oil prices feed into the calculation and as stronger demand and weaker supply in the economy increases inflationary pressures.

The BoE’s hawkish tone boosted sterling by about 1% against both the dollar and the euro while the two-year and 10-year government bond yields also rose.

A rise in May?

Ian Kernohan, economist at Royal London Asset Management, said the latest report significantly increases the risk of a rate hike in May.

He said: “Assuming there is no major economic shock, the MPC has judged that monetary policy needs to be tightened somewhat earlier, and somewhat more, than anticipated in November.

“Although the rate of GDP growth remains modest, the bank believes that trend growth has fallen. Inflation is still expected to fall back gradually, however the MPC notes some firmness in wage growth and expects that pay growth will rise further in response to a tighter labour market.”

Keep it steady

Andrew Morgan, portfolio manager of Alpha:r² at Walker Crips said he does not feel any need to change asset allocation given the next rise has been flagged for May and is no longer unexpected.

He added: “We therefore remain underweight fixed income assets, and remain short duration. We continue to be relatively defensively positioned in equities, despite the recent dip, and are looking at certain sectors – such as financials – which tend to benefit from a rising interest rate environment.

“Conversely, we are growing cautious on those companies which rely heavily on overseas earnings, as rising interest rates could cause the pound to strengthen further from here.”

 

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