OK, so rates have gone up, but just how worried should consumers be?

3 November 2017

Well, it would seem the majority of market watchers I've spoken to recently were right to make adjustments by pricing in a rate rise, given the Bank of England Monetary Policy Committee's vote today, resulting in a 0.25 per cent interest rate increase and taking interest rates to 0.5 per cent.

Analysts had predicted no great shift in the price of Sterling on the back of the rise, or little evidence of volatility around the currency. Sadly, this was not the case, as the pound almost immediately fell due to a feeling in the markets that the Governor appeared a little more cautious than expected.

FEXCO

Head of Dealing at FEXCO Corporate Payment, David Lamb's response is , “The ‘unreliable boyfriend’ has finally delivered, but it was far too half-hearted for the currency markets’ taste. Mark Carney’s prolonged campaign of hints had built market expectations up to such an extent that anything less than a full-blown hawkfest would be a disappointment – and so it proved. So, despite the 10-year wait, the Bank of England’s dovish interest rate rise has proved an anti-climax for the Pound.

Lamb, adds, “The MPC minutes confirm there has been no Damascene conversion of the rate-setting committee’s doves. Despite voting for a rise, the Bank’s rate-setters remain deeply worried about the lingering threats to Britain’s economy, and are willing to tolerate above target inflation for an extended period. Taken together, these factors mean the central bank will be in no hurry to hike rates further.

“Mark Carney’s press conference talked of any future rises being ‘gradual and limited’, but the markets’ conclusion has been more blunt – ‘one and done’. So the net effect has been to deliver a beating for the Pound, which is now losing the gains made as it soared on the pre-hike hype,” Lamb says.

Now, BoE Governor, Mark Carney, is left with the job of reassuring mortgage holders that this isn't the beginning of a rate rise trend. Something that will be alien to anyone under 28 years old who currently has a mortgage; this demographic has never experienced a rate rise during their adult lives.

Update

Admittedly, 0.25 per cent is a very small increase, but consumer confidence could still be affected - if a pervading feeling develops that credit interest rates will significantly stretch further an already stretched, and relatively underpaid, general work force's finances. Meanwhile, consequences for those on standard variable rate (SVRs) mortgages remain unsure, with some banks having already announced mortgage payments hikes for this group and analysts predicting further lenders will make similar announcements come early December 2017.

HSBC and Clydesdale/Yorkshire Bank have already implemented their tracker mortgage rate rises and Yorkshire Building Society will make the change from 8.00 pm tonight (3 November, 2017): meanwhile, Lloyds Banking Group, Nationwide, Santander; Barclays and the TSB have confirmed they will increase their variable rate mortgages at the beginning of December, 2017.

Only Skipton Building Society has, so far, announced it has "no plans" to increase its SVR for mortgage customers.

Responses to increase

The opinions from professionals in the Financial Services sector came thick and fast on the back of the decision:

Liontrust

Kenny Watson, the fund manager for Liontrust's Sustainable Investment team says: “We don’t see this as a ‘one and done’ policy action, and expect further hikes over the next two years, with a possibility of a rise next year. This is dependent on the UK successfully navigating its way through challenging Brexit negotiations, and we would also look for signs of wage growth picking up.

"Our current positioning remains being short interest rate risk as we continue to believe government bond yields will rise. It should be remembered that even after this increase, interest rates remain low, and the Monetary Policy Committee is still adopting an extremely accommodative policy. Provided there are no damaging shocks to the economy, we therefore see this as the beginning of a tightening cycle, although this will be gradual and to a limited extent by past standards.”

Watson's colleague, Jamie Clark, who is a fund manager within the Macro-Thematic team, describes the rate increase as "different from other global monetary policy ‘false alarms’ seen in the last few years." He concurs with Watson that this decision indicates higher rate rises s in the future. "This is because the economic recovery of the UK and other Western economies no longer makes depression-era monetary policy appropriate. The most recent labour market data showed the UK unemployment rate hitting 4.3 per cent in August – a joint 40-year low – below the 4.5 per cent rate at which the Bank of England estimates inflationary forces are in check," Clarks says.

He adds, " The prolonged period of loose monetary policy has led to some shares being mis-priced, and we have several key macro-thematic exposures which seek to exploit this. Broadly, they have a value tilt, and we would expect value to outperform both ‘bond-proxies’ and growth stocks under conditions of monetary tightening and higher discount rates.

"John Husselbee, the head of Multi-Asset at Liontrust, voices my assessment, that the debate 'has turned to whether this marks the start of a sustained tightening cycle'" or, Clark adds, simply represents a reversal of what critics now largely consider a premature cut in the aftermath of Brexit.

However, he says, "I would veer towards the latter. Despite some initial panic after the Brexit vote, the rate cut increasingly seemed unnecessary based on the market and economy’s subsequent performance. The Bank of England appeared keen to get the level back up to 0.50 per cent at the earliest opportunity and a pick-up in inflation has provided this."

At this point Husselbee says, Liontrust remains comfortable in the prevailing Goldilocks conditions, as low inflation and slow but steady growth persists. "The key question now is what exactly is making up that growth, and how this rate hike might affect it – and that is likely to dominate sentiment in the final months of the year and beyond,” he concludes.

Cavendish

Paul Mumford, manager of TM Cavendish Opportunities and TM Cavendish AIM at Cavendish Asset Management, says, "We’ve known for some time that the zero rate era can’t go on forever. But, with continued high levels of debt in the economy and business lending remaining anaemic compared to historic levels, there is a real question mark over how appropriate this rise is – and that’s not to mention the uncertainties around Brexit.

"Rises can harm the economy by killing off consumer spending, so it looks as if the Bank of England found itself between a rock and a hard place on this one. However some might argue that this only reverses a knee-jerk 'Brexit panic rise', which should never have happened in the first place.

"This rise is little more than symbolic, was expected and was factored into share prices and priced into sterling in advance. What’s more likely to cause market movement will be any indications of further, more significant rises. For example, although it might seem counterintuitive, rising rates could encourage house buyers to move quickly to lock in fixed rate mortgages at current levels.

"On the plus side, higher rates will be positive for cash-rich companies that are in a position to earn solid interest, and pension funds with large deficits, who may be in line for a much needed boost, given the impact on bond yields.

"Although gilts yields will be affected, minimal rises won’t bring returns anywhere near high enough to account for rising inflation – meaning equities remain the more attractive investment."

BrickVest

Emmanuel Lumineau, the CEO at BrickVest, sees todays rise as "momentous", and feels it should signal the start of a series of gradual increases for the UK economy . "The Bank of England has decided that inflation is potentially getting out of control and the economy now requires higher borrowing costs. The decision also signals that the UK economy has not performed as weakly as the Bank predicted last year," Lumineau says.

Taking into account that increasing interest rates have a direct impact on real estate, Lumineau - almost inevitably - acknowledges that higher interest rates and rising inflation make borrowing and construction more expensive for owners, "which can have a constraining effect on the market but can also lead to an increase in property prices," he says.

He adds, "There has certainly been an abundance of international capital flowing into real estate; almost every major institutional investor globally has been increasing their portfolio allocation to real estate over the last five years, mainly because of lack of alternatives."

Lumineau says BrickVest continues to see the highest level of volatility from the office sector, even as many international firms currently headquartered in the UK put decisions on hold over their long-term office space requirements.

"If the UK no longer gives businesses access to the European market they may need to spread their staff across multiple locations, to more efficiently access both the UK and European market. Indeed, our recent research showed that 34 per cent of institutional investors believe the biggest real estate investment opportunities will be found in the office sector, and the same number in the hotel and hospitality industry over the next 12 months,” Lumineau says.

Tilney

Jason Hollands, the managing director of Tilney Group, says, despite today's 0.25 per cent hike having been widely anticipated by the markets on the back of a notable shift in tone from Bank of England officials in recent months - as well as better than expected GDP data, coupled with inflation reaching a five year high of 3 per cent - nevertheless, "this is undoubtedly a decisive moment ... lifting rates off their lowest level in the 483-year [sig.] history of the Bank of the England [established 27 July 1694].

"Incredibly, it is estimated that around 8 million UK adults have never experienced a rise in borrowing costs, some of whom may assume that ‘emergency’ interest rates are normal."

Hollands emphasises it's important not to lose sight that interest rates remain "incredibly low, and the supply of credit is abundant." He sees the rate rise as more a case of "easing off the accelerator than tapping on the brakes."

Hollands says, "today’s move simply reverses the bank’s decision to slash rates in the immediate aftermath of the Brexit referendum; a move that in hindsight may have been overhasty and predicated on a much more gloomy prognosis, about the immediate impact of the decision to leave the EU, than what subsequently transpired. In the period since the vote, the resilience of the economy owes much to the consumer, but there are now real headwinds to consumer spending - with inflation outpacing wage growth. Much of the rise in inflation is attributable to the weakness of Sterling, which has pushed up the cost of imports, but this effect should pass through and a modest bit of monetary tightening should help address this."

Hollands adds that policy error is a real risk, and "the Bank of England needs to also carefully manage its messages to avoid triggering a market tantrum."

Viewing the UK’s rate rise as a part of a broader theme relating to central banks on the global stage, Hollands concludes that many of them are moving away from ultra-loose emergency monetary policy; "measures which have proved enormously supportive for both stock and bond markets over the last few years."

He says the US Federal Reserve is already hiking and may do so again in December. He also says, "The European Central Bank is set to taper its bond buying stimulus programme next year. Amongst major central banks, only the Bank of Japan looks set to continue pursuing ultra-accommodative politics for now. The tectonic plates are undoubtedly shifting."

Chase de Vere

Patrick Connolly, a certified financial planner at Chase de Vere, offers analysis on how the UK interest rate rise will impact equities and fixed interest rate investments:

Equities

Connolly says, " In theory, rising interest rates are bad news for stock markets; with the cost of borrowing increasing, individuals and businesses are both likely to have less money to spend on goods and services because they are paying more on mortgages and other debt."

It therefore follows he says, that an environment where individuals and businesses have less spare money will result in a bad performances environment for shares such as technology and consumer discretionary stocks, which include non-essential purchases like leisure and entertainment.

Interest rate rises are also likely to hit bond proxies, Connolly says, "which provide a consistent level of income and have been bought by many investors as an alternative to expensive fixed interest assets." This would include shares such as utilities and consumer staples like companies providing food, beverages and household items, he states. "These companies can perform well in any economic environment, but the value of their dividend stream becomes less attractive in a rising interest rate environment," the financial planner adds.

However he is not totally pessimistic, highlighting there are a number of companies that can still thrive in a rising interest rate environment. "This is especially the case when you consider that the UK has started to increase interest rates because the economy is looking in reasonable shape. This can provide a positive environment for companies to perform well and make profits,' Connolly says.

He also believes any further rises are likely to be slow and gradual, "so there shouldn’t be any nasty surprises." He adds that rising UK interest rates will, in theory, make Sterling stronger, benefiting UK importers and proving painful for UK exporters.

"The reality though is that, whether markets rise or whether they fall will be dictated by sentiment based on whether an increase is perceived as a positive or negative.

"The best approach for investors is likely to be picking active fund managers with strong track records who adopt a flexible approach, so they can focus on the sectors and the individual stocks, which are likely to prosper in whatever economic environment we find ourselves," Connolly says.

However, he is more emphatic when turning to fixed interest; he says, "Rising interest rates are bad news for fixed interest investments; with higher interest rates the fixed interest offered on bonds will look less attractive, and so prices are likely to fall and their yields rise to compensate". Connolly says higher interest rates also mean it will become more expensive for companies to raise money through issuing corporate bonds, as they will need to offer higher interest rates to attract new money.

"Fixed interest investments should play an important role in many people’s portfolios, although investors need to be aware of the downside risks and this most certainly includes the risks of rising interest rates," Connolly says; he adds, "the best approach to avoid the worst of any fallout in fixed interest stocks is likely to be to hold flexible strategic bond funds with experienced managers and investment teams".

Concluding, Connolly says, 'It is incredibly difficult to predict interest rate movements, as we have seen over the past decade, many experts have tried and failed. He re-iterates, " We don’t know for sure whether today’s rate rise will prove to be a one-off, or if it is the first of many. However, what we can say with some confidence is that any further rate rises are likely to be slow and gradual.

"The best approach for investors is to try not to be too clever," Connolly says. "They should hold a balanced and diversified investment portfolio including equities and fixed interest, which can achieve their objectives, regardless of what happens to interest rates in the future."

Brewin Dolphin

Guy Foster, the head of research at Brewin Dolphin says, "The rationale for a hike is simple. Inflation is high and is eating into consumers’ real incomes. Higher interest rates shouldn’t make too much difference for most consumers, as loans have been shifting gradually towards fixed rates.

"Around a year ago, 5 year fixed-rate mortgages started being cheaper than trackers." He adds, "The UK economy is fragile, and is suffering from a lack of investment as indicated by this morning's construction Purchasing Managers Index, which showed, again, that private commercial construction is weakening."

UK Finance

Eric Leenders, the head of personal at UK Finance, addresses what may be the concerns of many consumers and says, “Whilst this is a small rise from a historically low base, anyone who thinks they may find it difficult to manage their finances should always contact their provider as soon as possible, to discuss the support that’s available to help them. With most mortgage and personal loan holders, as well as businesses and credit card customers paying a fixed rate, many will see no change while their current deal lasts.

“Given that lenders offering variable rates assess a customer’s ability to pay at much higher interest rates, most should be able to cope with any increases as they filter down. Lenders consider a number of factors when deciding how to respond to a change in the base rate, and in this competitive environment - where it’s easy to switch providers - customers who are thinking about borrowing money should shop around to take advantage of the best deals on offer.

Meanwhile, he argues that savers will inevitably welcome a rate rise, "although the effects may not be felt immediately because banks will be looking to balance the increased cost of customer borrowing with the savings returns they offer.”

June Deasy, the head of Mortgage Policy at UK Finance, concurs, “The majority of borrowers will be protected from any immediate effects of today’s small increase because they have a fixed-rate mortgage. Over the last year, two thirds of first-time buyers have opted to fix their rate for up to two years, with a further one-in-four opting to fix for two to five years."

She adds, “Given that variable rate lenders assess the ability of applicants to pay at much higher interest rates, most should be able to cope with any increases as they filter down."

Ingrid Smith is a senior content strategist, storyteller & mentor