Russ Mould, investment director at AJ Bell, comments:
“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, although the MPC voted unanimously to leave its £445 billion Quantitative Easing scheme to buy government and corporate bonds unchanged.
“Although Kristin Forbes voted for a hike, she is leaving the MPC but the shift to a more hawkish stance from Ian McCafferty and Michael Saunders is a new development (even if McCafferty voted for interest rate increases six times in row in late 2015 and early 2016).
“The MPC seems to be responding to the increase in UK inflation to four- and five-year highs, as measured by the consumer price and retail price indices, even if some of the key causes of that spike – a higher oil price and a weaker pound – are now unwinding.
“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.
“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.
Previous rate cycles
“There have been 10 interest rate increase cycles since the inception of the FTSE All-Share in 1962.
“There are two clear performance trends.
“First, stocks have historically done better during down-cycles than up-cycles since 1970:
|
| Average |
|
| Duration of cycle (days) | Shift in rates | Market response |
Lower | 788 | -4.91% | 25.1% |
|
|
|
|
Higher | 434 | 4.76% | 11.4% |
Source: Thomson Reuters Datastream
“Second, the range of performance during rate-hike cycles is wide, with four drops and seven gains.
“Two of the last three were good for share owners and it does seem that the stock market has historically been able to take the strain of higher borrowing costs providing underlying economic growth and corporate profits growth were robust.
“The marked exceptions were 1976 and 2003-2007. The great financial crisis struck home in the latter case while in the former the UK was struggling to emerge from the 1973-74 recession and suffering from inflation in the mid-teens, with the new result that James Callaghan’s Labour Government had to go to the IMF for a $3.9 billion emergency loan.
FTSE All-Share performance | |||||
From | To | After first rate hike | |||
18-Oct-67 | 17-Nov-67 | 3 months | 6 Months | 1 Year | 2 years |
22-Jun-72 | 13-Nov-73 | 2.3% | 23.2% | 36.7% | 18.0% |
26-Apr-76 | 07-Oct-76 | -3.6% | 4.8% | -8.5% | -44.8% |
28-Nov-77 | 15-Nov-79 | -7.0% | -27.5% | 6.6% | 23.6% |
06-Jul-84 | 28-Jan-85 | -4.8% | 6.2% | 11.0% | 13.0% |
03-Jun-88 | 06-Oct-89 | 9.0% | 19.4% | 23.8% | 66.4% |
13-Sep-94 | 11-Feb-95 | -3.4% | -2.3% | 15.5% | 24.1% |
30-Oct-96 | 04-Jun-98 | -6.4% | -5.5% | 12.2% | 24.9% |
08-Sep-99 | 10-Feb-00 | 5.9% | 9.4% | 16.7% | 28.3% |
06-Nov-03 | 05-Jul-07 | 5.2% | 4.5% | 7.7% | -16.6% |
|
|
|
|
|
|
AVERAGE |
| -1.4% | 1.8% | 9.7% | 17.9% |
Source: Thomson Reuters Datastream
“The strength of the UK economy remains the big question this time around. There is no discernible follow through (yet) from the Trump bump and it looks like US economic activity is slowing in the first half of 2017, while the UK’s Q1 GDP number disappointed.
“In addition the West must still face the long-term challenges posed by record debt levels and unhelpful demographic trends, in the form of ageing (and potentially) shrinking populations.”