Nicholas Wall, manager of the Old Mutual Strategic Absolute Return Bond Fund at Old Mutual Global Investors, considers the arguments for and against the Bank of England (BoE) raising interest rates next Thursday.
For a nation that has endured the trials and tribulations of Love Island over the summer, the original unreliable boyfriend returns next week. Will the Bank of England governor Mark Carney deliver the 0.25% rate hike that the market expects?
We think the central bank will jump at this opportunity. It has been clear for some time that policy makers have wanted to raise the benchmark rate from the current 0.50% level, but other developments kept getting in the way. The economic data in the first quarter was weak, partly due to cold weather, while Brexit negotiations and US trade wars proved chaotic, creating an uncertain environment for business and triggering a collapse in foreign investment in the UK.
However, a modest recovery in the economic data, as Carney predicted, has presented a window of opportunity. Employment growth has been very strong and the football World Cup helped retail sales. While UK GDP is not at blockbuster levels when compared to before the financial crisis, today there is less potential for growth due to weaker productivity and demographics. In the current environment, the latest figures actually appear reasonably healthy.
Brexit uncertainty and geopolitics are the main reasons to keep rates on hold, but no one really knows what the endgame for either will be. And besides, the BoE may want some ammunition should the worst-case scenarios materialise. For Carney the Brexit trade off was always between jobs and household disposable income – he sacrificed the latter via a weaker currency, but given how low unemployment is, the scales have tipped back.
Investors are expecting this rate hike so if the BoE does tighten policy, the reaction in gilts and sterling should be modest. There are, however, practically no rate rises priced into the market after this, so should the UK government lead us towards a softer Brexit and the improvement in the economic data continue, then gilts suddenly look very expensive.
So in summary…
Arguments against a rate hike:
– Trade wars
– Real wages and inflation
Arguments for a rate hike:
– Growth may not be that strong, but is reasonable considering the reduced growth potential post-crisis
– Strong retail sales and manufacturing data (PMIs)
– High job creation