US hikes interest rates while UK rates are held: experts say UK unlikely to follow US

Published by Moira O'Neill on 16 March 2017.
Last updated on 16 March 2017

The US Federal Reserve has raised its interest rate from 0.75% to 1.00%.

This came as no surprise since the financial markets had priced in a 95% chance of this happening.

By contrast, the market (based on overnight index swaps) is pricing in a 75% chance that interest rates will still be at 0.25% in the UK at the end of this year, with only a 25% chance of a rate hike in the course of 2017.

The Bank of England MPC has voted to keep interest rates on hold, despite expecting inflation to rise above its 2% target in the near term. The Bank reiterated its February judgement that household spending growth will slow as real incomes come under pressure, a combination of rising prices and weak wage growth.

Jonathan Chitty, investment analyst at Brown Shipley, says: “Though unsurprising, the Bank of England’s decision to hold rates comes as unemployment and spending remains strong and inflation creeps higher – conditions under which central bankers would usually consider hiking rates.

 

“However, perhaps the most interesting detail of today’s decision is that support for keeping rates at historic lows is no longer unanimous, with Kristin Forbes voting for a 0.25% increase. This is the first dissenting vote in favour of rising rates for some time, and when considered alongside the more ‘hawkish’ comments in the BoE’s release it should provide some support for the pound going forward.”

Experts warn rising interest rates tend to be bad news for bond prices and have also traditionally been viewed as bad news for emerging markets funds, as higher US interest rates mean a strengthening of the dollar which depresses emerging market currencies.

Anthony Doyle, fixed interest investment director at M&G Investments says: “Interest rates are likely to remain on an easy setting in the UK, Europe, and Japan causing a widening in interest rate differentials to the US, suggesting a further strengthening of the US dollar versus the majors.”

 

“Cash savers are likely to be disappointed”

Laith Khalaf, senior analyst at Hargreaves Lansdown says: “UK interest rates look set to stay anchored to zero for the foreseeable future, and the prospect of a Scottish referendum, on top of Brexit, does little to encourage the Bank of England to peek its head above the parapet.

“Likewise, the latest official pay growth figures were distinctly unimpressive, and suggest there is little momentum in the underlying economy which is going to force the bank’s hand in raising interest rates.”

Helal Miah, investment research analyst at The Share Centre says: “The UK is not expected to raise rates for at least a year. We therefore believe that the equity market still represents the asset class of choice offering capital growth and superior income levels.”

Mr Khalaf adds: “Cash savers are therefore likely to be disappointed if they are expecting an end to the interminable wait to get a decent return on their money any time soon. To add to this concern, the return of inflation in the UK as a result of weaker sterling and recovering commodity prices, is likely to make cash returns look even less appealing in the coming year.
“Meanwhile across the pond the central bank is facing a very different set of circumstances, and is expected to hike rates several times this year.

“Further divergence in monetary policy can be expected to continue to underpin the strength of the dollar, though this may be a limiting factor for the Federal Reserve when it considers raising interest rates, as it may not wish to push the currency too far ahead of its peers lest it damages the US economy.

“Higher US interest rates will also push up the yield on US Treasuries, and that can be expected to have a knock on effect on the gilt market and UK government borrowing costs.

“However that will be tempered by interest rate expectations in the UK, which is why the 10 year US Treasury already commands a healthy premium to the 10 year UK gilt, offering a yield of 2.6% compared to 1.2% respectively.”

Where to invest?

Tom Stevenson, investment director for personal investing at Fidelity International says: “Ultimately, rising rates in the US and a higher US dollar can help foster an equity friendly environment. That’s because investors tend to focus in the early phase of a tightening cycle on the reason for rates rising rather than on the ultimate impact of higher rates on economic activity. With this in mind, investors may want to consider a global equity fund.”

Mr Stevenson recommends:

Rathbone Global Opportunities Fund, which has a significant US weighting and focuses on technology stocks such as Amazon and Facebook and on consumer names such as Visa. The manager, James Thomson, has a focus on finding companies with a sustainable growth story and is prepared to pay up for quality. He likes to find under-the-radar or out-of-favour companies.

Fidelity Global Dividend Fund. Its manager Dan Roberts scours the globe for attractive income streams but never compromises on quality - he is intimately concerned about preserving investors’ capital. To that end, he places heavy emphasis on scrutinising financial statements to ensure that companies can afford to pay the dividends which they are offering.

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