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US raise rates, while UK holds fire; but what does it mean for investors?

7 months ago

In a world of rising inflation and rising interest rates, fixed income assets tend to suffer.

Adrian Lowcock

The US Federal Reserve has decided to raise interest rates by 25 basis points in-line with market expectations and the Central Bank’s own guidance of a path to slow interest rate normalisation. Given the health of the US economy this move and further interest rate rises are to be expected.

The US is seeing solid growth and low unemployment whilst consumer and business spending is up. Inflation in the US has been noticeable by its absence, but there are early indications it is starting to pick-up. This is an issue that concerned markets in January and February this year. However, the pick-up in inflation has not been enough to concern the Federal Reserve as yet which should reassure markets. However, if inflation does surprise on the upside then sentiment could change quickly as investors grow concerned the Fed were behind the curve all along.

Less than 24 hours later the Bank of England Monetary Policy Committee decided to keep interest rates as they were at 0.5%. Whilst the UK economy continues to grow and unemployment is low the country faces an unclear future. Brexit negotiations seem to cast a shadow over the country and there is a huge amount of uncertainty about the UK economy. Given this backdrop the Bank of England have decided it would be more prudent to adopt a wait and see approach to interest rates.

This approach makes sense as UK inflation, the consumer price index, has fallen from its recent high of 3.0% in January to 2.7% in February and is expected to ease further in the short term. However, as the year progresses inflation issues could return; employment is growing at a faster rate, while the unemployment rate continues to fall and there are signs of a rise in annual pay growth. All of which suggests a tightening labour market. As the labour market tightens there will be increasing pressure to raise wages, driving domestic inflation higher. This could and would need to be controlled by the Bank of England raising interest rates, although they would follow the US approach of gradual and limited.

In a world of rising inflation and rising interest rates, fixed income assets tend to suffer as the yields offered can only be adjusted by changes in the underlying prices – i.e. prices need to fall for the interest rate to rise. Equities tend to benefit from moderate inflation and gently rising interest rates and with global growth looking fairly stable the outlook for equities in general looks positive.

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