The Bank of England’s (BoE’s) Monetary Policy Committee (MPC) met last Thursday and voted to keep interest rates at the historic low of 0.25%. However the minutes of the meeting showed that three members (out of eight) voted to increase interest rates. The voting was considerably more hawkish than previously, with only one MPC member voting to increase interest rates at the last round of voting. This would usually be indicative of interest rates rising in the near future.
The MPC members who voted to increase the BoE base rate, cited the recent higher inflation as a reason. Inflation has picked up to 2.9%, well above the 2% target. Setting the base rate is one of the BoE’s principle tools for controlling inflation. Interest rates are generally increased to seek to control higher than targeted inflation.
Inflation has increased following the fall in sterling as imports have become comparatively more expensive. Many economists argue that inflation is only temporarily higher; with slow economic growth, inflation will naturally fall and therefore there is no need to push rates up to control it. Furthermore any increase in interest rates is likely to put an increased burden on households, as two thirds of all mortgages are linked to the base rate.
While we agree with the consensus that interest rates are unlikely to rise in the short term, we will eventually see an increase from these historic lows. When rates do increase, bond yields will increase and therefore bond prices will fall. Equities may also see valuations fall but will conversely benefit from higher inflation. We continue to hold fixed return investments with a low sensitivity to interest rate movements and exercise caution in looking at stock valuations.
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