JPM Fund Manager

Is the recent rate rise the beginning of something bigger?

Callum Abbot discusses the recent rate rise.

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Nov 06, 2017
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On 2 November 2017, the Monetary Policy Committee (MPC) of the Bank of England (BoE) voted 7-2 in favour of a 25 basis point (bps) increase in the base rate to 0.5%. This marked its first rate rise since 2007—the year the first IPhone launched!

Doves broadly argue that now is not the time to raise rates given the UK economy is slowing, largely due to the weak consumer, and the Brexit negotiation is adding uncertainty and risk to economic growth. Indeed, it could be argued the rate rise was unnecessary for several reasons.

First, the December EU Summit is widely viewed as crunch time for Theresa May to get approval for a transition deal that maintains the status quo while a full trade deal is worked out. At the January meeting, the MPC would have had more clarity on the direction of Brexit allowing for a better-informed decision on monetary policy. Second, there is not much evidence that low employment is translating into higher wages and that slack remains in the economy. Third, inflation has been a result of the drop in sterling following the EU referendum vote, the worst of which has been lapped and so should reduce naturally. 

Hawks have argued that unemployment, at 4.3% (Source: International Labour Organisation as at August 2017), is at record lows and that a rate hike will support sterling. Some have put forward the argument that a higher interest rate will lead to prudent management of household balance sheets. This hawkish position was backed up by third-quarter UK GDP figures coming in 10bps ahead of expectations and the UK composite Purchasing Managers’ Index at 55.8 (Source: Markit as at October 2017), indicating future growth.

However, too many false starts saw BoE Governor, Mark Carney, dubbed an “unreliable boyfriend”, and with the Bank’s relationship with the market and politicians showing some strain there was only one thing that the MPC could do: deliver on its telegraphed intention to raise rates.

What accompanied the rate rise was a dovish statement that framed this as a “one and done” reversal of the cut following the EU referendum last year. Unlike previous statements, there was no reference to the possible need for more rate hikes than the market was expecting. At the same time, the BoE published estimates of the long-run UK economy that forecast muted economic growth (1.7% in 2020,  Source: Bank of England November 2017 Inflation Report) mainly due to supply-side weakness (lack of productivity and slowing labour supply growth). These forecasts are in the context of a smooth adjustment to the new UK/EU relationship.

On the day, the market response was sterling down 1.62% (Source: DB GBP Trade Weighted Index as at 02.11.17), gilt yields were marginally down and the FTSE All-Share was up 0.6% at close of play on the day of the announcement. Market expectations for the next rate rise have been pushed out to September 2018 from May previously. 

UK consumers will take a small hit to their mortgage costs, but with the base rate still very low at 0.5% and 80% of new loans and 50% of the total stock of outstanding loans fixed,[1] the impact will be fairly muted.

In regard to the UK equity market, dovish sentiment has led to sterling weakness and therefore support for the foreign revenue streams of the stocks that make up the FTSE, which source 70% of their earnings from overseas.

[1] Source: Bank of England and Council of Mortgage Lenders as at 12.09.17.

Callum Abbot is portfolio manager for JPM UK Equity Plus. Read more about the fund: UK Advisers 

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Go to the profile of Callum Abbot

Callum Abbot

Portfolio Manager, JPM UK Equity Plus Fund , J.P. Morgan Asset Management

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