A friend once told me that you can’t go far wrong by walking in the opposite direction to the signposts at Kings Cross underground station.
Whilst that has proved sound advice over the years, it could equally have been applied to that venerable City institution, the Bank of England and, more specifically, its Governor, Mark Carney.
For some time, Mr Carney has been warning households and the City that interest rate rises are imminent, only for the Monetary Policy Committee (MPC) to backtrack, preferring a wait and see approach. Fixed income investors who took the opposite position have by and large been well rewarded as gilt yields have fallen further when the mooted rate rises failed to materialise.
These mixed signals earned Mr Carney a reputation in some quarters as “an unreliable boyfriend” with one MP suggesting, not unreasonably, that people have no idea where they stand on future interest rate rises.
This all looks set to change. In recent weeks, gilt yields have started to harden and – after so many false starts – the MPC cannot put off the inevitable much longer. It is important to remember that interest rates of sub-1 per cent were an emergency response to the aftermath of the financial crisis in 2007/8. They were never meant to stay at these levels for any longer than necessary.
Whilst the strong expectation is that interest rate rises from here will be very gradual, one shouldn’t underestimate the implications on the psychology of the Great British
consumer of the first interest rate rise for more than a decade.
The timing of the first rate rise may be unfortunate. Anecdotal and survey evidence suggest a gradual slowdown in a number of sectors this year, be it construction and
the housing market, leisure or new car sales. The latter were down nearly 10 per cent year-on-year in the normally strong month of September and it’s a long time since I have
received as many money-off restaurant emails in my Inbox.
But inflation is rising, driven to no small extent by the devaluation of sterling in the aftermath of the Brexit vote last summer. This is being felt in many areas from clothing down to the weekly shop. This matters as the MPC’s remit is to achieve a symmetric inflation target of 2 per cent as measured by the 12-month increase in the Consumer Prices Index. Data for September is due to be released this morning but CPI has been above target every month since February. If today’s reading starts with a 3 then Mr Carney will be forced to write an open letter to the Chancellor explaining why the MPC has been unable to fulfil its remit.
Although this is not without precedent (the last such letter was in December for an undershoot rather than overshoot), it will likely compound the pressure for action on rates sooner rather than later.
A further cause for concern of the current accommodative stance is there are signs of excess emerging once again in certain areas of the lending market. Car finance, for example, is firmly in the sights of the Bank’s Financial Policy Committee. Wider consumer credit growth of over 10 per cent a year prompted independent ratings agency Moody’s to warn over summer of a risk to credit card lending quality. The signs are there.
So, we are perhaps approaching a perfect storm, one whereby the MPC needs to raise rates to control inflation and reassert its own credibility when the consumer-led economy is starting to slow down on its own. And this time, it appears markets are taking the prospect seriously. This makes for an awkward end to 2017.
Which sectors fair best and worst in times of rising interest rates?
Consumer discretionary stocks are generally best avoided in an interest rate tightening cycle as people shop less and prioritise the essentials. Anticipation of this has already led to a de-rating this year of shares in the car dealerships, sofa and carpet retailers, for example.
Fixed income stocks such as gilts and corporate bonds can also be volatile as their value is usually inversely proportion to their yield, ie, rising yields = lower prices, all other things being equal.
So-called defensive stocks, which would include utilities, food retailers and other suppliers of staple goods, are generally in favour as people will always need to eat and keep warm.