Page 4 - ISQ UK_October 2017

INVESTMENT STRATEGY QUARTERLY

Is the Bank of England

on the Cusp of Tightening Policy?

Chris Bailey, European Strategist, Raymond James Euro Equities*

"Lower interest rates are usually considered good for stocks because they lower the cost of borrowing and
make bonds a less attractive alternative investment" Alex Berenson

What were you doing on the 5 July 2007? I cannot remember either,
but the history books tell us that this was the last date when the Bank Given the uncertainties
of England raised interest rates (by a quarter of a percentage to
5.75%). Since this point, interest rates have only fallen, including the around Brexit and recent
most recent August 2016 decrease to the current rate of just 0.25%. economic growth data this

But is this about to change? Traditionally, independent Central Banks has caused a conundrum for
with relatively narrow inflation control mandates, like the Bank of
England, typically raise interest rates when the level of price increases the Bank of England
threatens to pierce their target inflation level. For the Bank of England
this moment was, a number of months ago, influenced by the impact
on imported prices, like energy, by the sharp fall of the Pound in the the reality and can we expect, for the first time in over a decade, an
second half of last year. increase in interest rates?

Given the uncertainties around Brexit and recent economic growth The economic case for an interest rate increase is currently not wholly
data, which has been typically weaker than other developed market proven. Brexit negotiations are an uncertainty and the average
peers, this has caused a conundrum for the Bank of England. Reflecting consumer remains under pressure with limited wage increases and
this, the Bank’s own Monetary Policy Committee (MPC) observed a high personal debts. However, monetary policy remains exceptionally
few weeks ago, after a meeting which concluded that interest rates loose with a negligible 0.25% base interest rate, the Pound on a trade
should be currently held, that: weighted basis near multi-decade lows and a quantitative easing
stimulus programme, which was further augmented at the time of the
“The MPC’s remit specifies that, in such exceptional circumstances, the last interest rate reduction in August 2016 when the big fear was an
Committee must balance any trade-off between the speed at which it imminent shift of the UK economy into recession.
intends to return inflation sustainably to the target and the support
that monetary policy provides to jobs and activity.” In short, a very mild tightening of policy - maybe reversing some of the
extraordinary additional stimuli measures implemented fourteen
‘Exceptional circumstances’ covers a variety of sins but maybe months ago - is quite plausible and would reflect an acknowledgement
something has changed in the water at Threadneedle Street because that, whilst the backdrop is still uncertain on an absolute basis,
Mark Carney, the Governor of the Bank of England, in an even more relatively speaking there is slightly more clarity. However, the bigger
recent national radio interview said that ‘we can see that in the coming insight is that anyone expecting a return to the interest rate or broader
months if the economy continues on this track it may be appropriate monetary policy norms of the generation before the global financial
to raise interest rates’. crisis a decade ago is going to be incorrect.
Well that is a surprise - and certainly induced an immediate response The Bank of England is not the only central bank coming to these
from both the bond markets as well as mortgage lenders. So what is conclusions. The Federal Reserve in the United States was the first

*An affiliate of Raymond James & Associates and Raymond James Financial Services
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