8th August 2014
Mindful Money looks at the expert views about interest rates in light of the Bank of England’s decision to maintain the base rate at 0.5%.
Could there be a split in the MPC vote in coming meetings?
Kames fixed income manager John McNeill says: “The Bank of England has again kept Bank Base Rate unchanged at 0.5% and the size of the Asset Purchase Facility at £375bn. Recent activity indicators have confirmed the solid progress that the U.K. economy is making. Employment growth is strong, but wage pressures are notably absent. The prospect of a split MPC vote has certainly increased as some members may feel that moving rates sooner will mean that they ultimately need to rise by less.”
A small rise would have a significant effect
Neil Lovatt, director of financial products at Scottish Friendly, says: “Despite the Governor of the Bank of England saying in June that interest rates were likely to go up sooner rather than later, today’s announcement means they have now been pegged at this rate for five years.
“It’s still expected, however, that rates will rise. We expect any rate rises will be small because we are likely to remain in a low interest rate environment – the landscape has changed from what it was before. Nowadays very small rises in interest rates will have a significant effect on what is still a fragile economy.
“Any savers thinking that the ‘good old days’ of high interest rates will return are going to be sorely disappointed and the sooner we adapt to this environment the better.”
A rise in the UK and US is inevitable perhaps before the end of the year in the UK
Andrew Wilson head of investment says: “We are currently at an interesting juncture for financial markets, with UK and US interest rate rises inevitable – perhaps before the end of 2014, particularly in the UK.
“Meanwhile the ECB and Bank of Japan are lowering borrowing costs in an attempt to prevent deflationary pressures and stimulate lacklustre economic activity respectively. The Chinese also appear to be re-stimulating slightly, which may not help their longer-term rebalancing, but should help the global economy in the shorter term.
“Leading indicators are continuing to foretell stronger growth for the remainder of H2, which would make an interest rate rise more likely both at home and in the States.
“The impact of a rate increase is difficult to assess, and only time will tell. Rising interest rates are not generally good for asset prices and markets normally start to price them in, in advance. That said, if rates are rising because the economy is strong, then this need not worry equities too much, especially for the first few increases when they are from such a low base. There is a growing consensus that rates need to settle at around 2-3%, rather than nearer 5% as in the past.
“If the economy is strengthening, then corporate and high-yield bonds can still perform well for a bit, even with rates rising. Their yields will need to stay competitive, however. You should ensure you maintain flexibility in your investments by picking bond fund managers who target areas linked less strongly to the underlying base rate.
“Government bonds in the UK and US are facing the unwinding of quantitative easing policies and potential increases in interest rates, and so they remain unfavourable. The recent strong performance of commercial property meanwhile should continue to at least the end of 2015.”
Implications for rates, bonds and currencies around the world
Scott Thiel, head of the Global Bond Team at BlackRock says: “No changes were made to the European Central Bank (ECB)’s monetary policy stance today. The main refinancing rate remains 0.15%, the deposit facility rate is still negative at -0.1% and no new policy announcements were made.
“However, in the press conference that followed, President Draghi made some interesting observations, among which: he acknowledged that ECB and US Federal Reserve (Fed) monetary policy stances would diverge for a long time (one of our favourite investment themes); that data suggested a slowing of growth momentum in the euro area; that fundamentals for a weaker euro ‘are much better’; and that any future QE programme initiated by the ECB could include the purchase of asset backed securities (ABS).
“We are currently cautious towards the global bond market environment. We see the potential for volatility and liquidity issues to arise once markets begin to focus on the large imbalances that have occurred from rates being so low for such a very long time, particularly by the Fed and Bank of England (BoE).
“We do remain short or underweight gilts and long British pound, on the expectation that the Bank of England will be the first major central bank to raise official interest rates (currently at 0.5%). The BoE kept interest rates on hold at today’s meeting of the Monetary Policy Committee.
“We are now roughly neutral in the European periphery, cognisant not only of the recent spread compression but also the switch in market focus from fundamentals to ECB support in the eurozone.
“There has been a lot of attention on Portugal in recent weeks, given the losses at the country’s largest lender, Banco Espirito Santo. We took profit on our overweight position in Portuguese sovereign bonds ahead of the June ECB meeting. In the last few days, the government announced a plan along with the European Union to rescue the bank. However, ratings agency Moody’s upgraded Portugal to Ba1 (one notch below investment grade) on 25th July1, citing among other things a strong government commitment to fiscal consolidation, regained market access and a comfortable liquidity position.
“We retain our long-standing preference for being overweight subordinated European bank debt. Both the new targeted longer-term refinancing operations (TLTROs) and the potential ABS purchases announced by the ECB should be positive for European banks, which would support this view.
“In the emerging market space we continue to like local currency bonds in selective economies, namely India, South Africa, Turkey and Brazil. We believe that inflation has peaked and domestic demand is now weak enough for these central banks to stop raising rates.
“Among our active currency exposures, we expect to continue to see an unwinding of safe haven trades and as such we remain short CHF versus EUR and are also now long USD against CAD.
“Finally, we are long Poland against the Hungarian Forint based on the relative fundamental strength of the Polish economy and we remain long the Chinese renminbi on medium-term balance of payments dynamics and the ongoing liberalisation of financial markets in China.”