How soon can we expect interest rate rises?

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When the pandemic first hit in March 2020, the Bank of England quickly reacted by cutting interest rates to their lowest ever level of 0.1% – done to help businesses and individuals cope with the economic damage the virus would cause.

Fast forward 19 months later, and rates have remained at the record low. But with the UK economy fully reopen and on the road to recovery, there’s talk the Bank of England are getting ready to raise interest rates.

In October’s Skipton Insight we speak to Karen Follows, Money Market Dealer at Skipton. Karen tells us how she sees interest rates shaping up over the next year or so, what factors are determining the Bank of England’s decision making, and – of course – what it might mean for you as an investor.

When are interest rate rises expected?

In September the Bank’s Monetary Policy Committee (MPC) voted to keep rates at 0.1%. But it’s thought they’ll soon be the first major central bank to raise its interest rate.

Karen Follows, Skipton’s Money Market Dealer

Currently, markets are pricing in a rate hike for quarter one of next year – with this likely to take place. There’s then expected to be another hike around June or July of next year.

Karen Follows, Skipton’s Money Market Dealer.

At the beginning of October, Michael Saunders, one of the Bank’s policymakers said investors were right to expect a rate increase in the near-term – particularly as inflation is on course to rise above four per cent.

Karen continues, “The problem when it comes to trying to exactly predict how it’s going to play out is things are changing all the time. There was some talk at September’s meeting that the Bank could go as soon as November. We think that’s unlikely, but with a mandate of managing inflation, action is likely to be required in the not too distant future.”

A number of factors at play

There’s a lot for the Bank to think about at the moment, with several key issues influencing their decision making on interest rates.

The end of furlough in September made the UK the first big economy to wind up its Covid-19 jobs support scheme. At its peak it covered a third of employees – the most expensive part of UK economic support for the pandemic.

Now furlough has ended, the outlook for employment will play a key role in the Bank’s decision. Early readings suggest the job cuts expected due to the scheme finishing have not happened. The number of firms planning redundancies was close to record lows in September.

Bank of England officials have a range of views on the likely path of unemployment now that furlough is no more. With this in mind, they’ve opted the best course of action to take is to wait for official data to be released – likely to be towards the end of the year.

If the labour market looks strong once the figures come through, this could translate into more sustainable inflation – which is what is likely to cause the Bank to act.

Karen continues, “When it comes to furlough it’s likely to be a wait and see game in terms of the impact it’s had. There is a suggestion that bigger businesses who use the furlough scheme intend to keep their staff employed. Whilst this is good news, the Bank won’t be basing their decision on this, and instead will wait for the official statistics to be released, which should be due in the next month or so.”

But the end of furlough isn’t the only factor the Bank is dealing with at the moment.

Continued supply chain issues

Karen explains, “There’s a difficult supply environment which markets are expecting will persist for another 12 months at least. For the immediate short-term, businesses are warning ahead of the all-important Christmas trading period.”

Two-thirds of UK manufacturers expect to raise their prices in the run-up to Christmas – with staff and raw material shortages to blame. The boss of Heinz recently said the company would be putting up prices of products in several countries. And the country’s biggest supermarkets – Tesco, Sainsbury’s, Asda and Morrisons – have lost out on more than £2bn worth of sales this year so far due to food shortages, according to data from the Grocer magazine.

In September, the fuel crisis wreaked havoc across the country’s petrol forecourts, and then there’s the ongoing energy crisis. UK gas prices started the year at 60p per therm (unit of energy), but high global demand and reduced supply has driven prices up – at one point it was trading at 400p per them.

Karen continues, “The MPC will be concerned about energy price rises. There is quite a lot of noise about this at the moment – particularly how it will impact inflation. There are an awful lot of different views on inflation. A lot will rely on what happens with energy prices and the supply issues.”

Inflation - the deciding factor?

The main factors at play here – promising employment figures, an increased demand for goods, and continuing supply chain issues – create a perfect storm for rising inflation.

In September inflation was at 3.1%, and it’s expected to further rise to about 4.0%.

While the higher rates are expected, the Bank’s main concerns are that inflation will go above its 2.0% target for a prolonged period of time. And it could even be the factor to force a more urgent response from the Bank – although they remain confident that inflation will return to target levels by 2023.

Karen tells us, “Higher inflation will persist for longer than initially thought – markets expect inflation to peak in a few months. But what it will peak at is another question, especially as there are quite a few factors influencing inflation at the moment.”

The impact on markets...

In the short-term it will become a balancing act for the Bank – ensuring inflation remains under control, while allowing the recovery from the pandemic to continue.

Karen concludes, “All eyes will be on November’s meeting and what the MPC say during this. Between now and then there are three main things they’ll be keeping an eye on. Concerns around inflation, they’ll also want to see the knock-on effects – if any – of the furlough scheme coming to an end. And then there’s supply shortages, which feeds into levels of inflation.

“The Bank will want to tread cautiously, and maybe wait a few months to digest a bit more of the data as it’s released. There are reports the first hike could come quarter one of next year, but this is not nailed on. All it could take is some new data to come to light next week, and this consensus could once again change.”

In terms of the impact a rise in rates will have on markets, it’s unlikely to have a huge effect. Markets have already fully priced in the chance of a rise early next year, and they’ve half priced in one for December too – so it is highly expected in the near term.

And while the media talks of ‘hikes’ to interest rates, any increases are likely to be gradual. In all probability, interest rates will be at relatively low levels for some time to come. But one thing is for sure, interest rates and inflation will always be part of the investing world – and they’re two factors that are likely to never be plain sailing.

There are some assets that benefit from slightly higher levels of inflation and low interest rates. And vice versa, there are assets which prosper during lower levels of inflation and higher interest rates. But – as we always stress here at Skipton – that’s why holding a diversified portfolio comes in really useful.

Please bear in mind that our comments should not be considered as advice, and the economic and market conditions of the past may not be repeated in future.

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