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To raise or not to raise - that is the question ...

1 November 2017

With the first interest rate increase for 10 years on the cards, James Andrews, Director - Head of Investment Management, discusses the Bank of England’s next potential move

"UK inflation hit a five-and-a-half-year high last month, with the consumer price index rising three per cent year-on-year. Meanwhile, unemployment is at a 42-year low of 4.3 per cent. The expectation is that the Bank of England will tomorrow (Thursday) increase interest rates for the first time in 10 years.

"Does this mean we are now set to see a period of tightening, with interest rates rising back to more ‘normal’ levels? My view is no. This will be a one-off rise with a ‘wait and see’ mandate for some time to follow.

"The reason for this belief is centred on Bank governor Mark Carney’s June comments, where he essentially said, in reference to whether rate rises are necessary, and the magnitude of any potential rate rises, will depend on: “…the extent to which weaker consumption growth is offset by other components of demand, including business investment, whether wages and unit labour costs begin to firm, and more generally, how the economy reacts to both tighter financial conditions and the reality of Brexit negotiations.”

"That leads me to look at those indicators that he highlighted as being of greatest importance to the Monetary Policy Committee in deciding whether to raise rates or not: business investment and wages.

"Business investment rose 2.5 per cent during the second quarter of 2017, versus the same period last year. Given strong business growth is deemed to be between five and 10 per cent, the 2.5 per cent growth we are seeing currently is pretty low. Furthermore, surveys of the construction industry show commercial building work has slowed as new orders are not replacing previous work, with the British construction sector now contracting.

"Elsewhere, investment by UK manufacturers in new plant and machinery has slowed to 6.5 per cent of turnover, from 7.5 per cent last year, according to a survey by industry trade body EEF. This, again, seemingly reflects the post-Brexit uncertainty.

"If we turn to the other indicator that Carney spoke of back in June, namely wages, we see that real wages across the UK fell for the sixth straight month in August, as wage growth continues to lag inflation. Data released on 18th October showed basic wage growth was 2.1 per cent during the three months to the end of August, the same as the previous quarter.

"Finally, if we look at the recent UK GDP growth figures of 0.4 per cent quarter-on-quarter, this was a slight positive surprise, but the context is a growth rate at half the pace the UK economy was growing at prior to the financial crisis, and slower than the pace seen in the subsequent recovery between 2009 and 2014.

"Despite all this, markets are pricing in a 90 per cent chance of a rate rise of a quarter of a percent tomorrow. I think the rationale lies in what the last of the rate cuts was designed to do. Essentially, it was viewed by the Bank as an emergency shock-absorbing measure post the Brexit vote - however, with the UK economy not suffering as severely as had been feared, the Bank will feel justified in removing the emergency measure. This allows them to see how the economy takes the rate rise and look at the inflation data for longer, given core inflation is still not as concerning as the overall inflation number. Finally, a small rise gives a little room for a cut should the worst fears over Brexit come through.

"Whatever happens tomorrow, what remains constant is the need for a balanced and patient approach to investment in what are interesting times."

Redmayne-Bentley does not provide advice on life assurance and other financial planning products and, therefore, are recognised by the FCA as a ‘restricted’ advice firm. Investments and income arising from them can fall as well as rise in value and you may lose some or all of the amount you have invested.

 

Author: Ruth Peterson

Contact Us: For all press and media enquiries, the first point of contact is media@redmayne.co.uk or by calling 0800 195 2579. Alternatively request call back.

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