UK rate rise: '˜one and done' or beginning of rate hiking cycle?

3 November 2017

It has been an eventful start to November, following a full-on October that generated pleasing returns for investors in global capital markets (see table left). The financially interested UK public will have focused on the first interest rate rise in the UK for more than a decade - by 0.25%. Two weeks ago, we had covered the UK's developing inflation and interest rate dynamics in our second article and strongly suggested that this 0.25% rate rise would happen this week. Our readers will therefore have been as unsurprised as markets were and so the little market reaction there was to the announcement by the Bank of England (BoE) on Thursday was actually a small but still counter intuitive decline in short term yields and £-Sterling.

This would have been a reaction to what one City commentator called the '˜least committed rate hike we could have expected' - on the basis that the BoE's accompanying comments focused more on the weaknesses of the UK's economic situation - hardly a backdrop for further rate rises next year. Nevertheless, the rate setting committee's indication that another two 0.25% rate rises over the next 24 months (!) were likely, may still be sufficient to prevent a deterioration of £'‘Sterling's value beyond the recent lows. This in turn could indeed be the best medicine of the UK's central bank against further inflationary pressures which thus far have not been caused by rising wages, but increasing prices of imported goods.

So, is there now the risk of increasing pressure on the mortgage laden UK public, which would further undermine the UK consumers' propensity to spend? Well, at this pace probably little. The BoE itself estimates that the average mortgage burden will increase by £15 per months. But even from that angle, the Financial Times reported that due to lower home ownership, only 24% of UK households now even have a

mortgage (compared to 34% in 2000) and only 9.6% remain on variable rate mortgages, while the over 14%, who are on fixed terms, will initially be unaffected.

As a consequence, we see our view confirmed that despite all the rate rise rhetoric, the BoE remains on a very glacial path of rate rises, which for the time being has minimal impact of the discretionary spending power of the UK consumer. But make no mistake - unless the UK falls into a Brexit induced recession - the direction of travel of interest rates and bond yields has been reversed and points upwards from here.

Other notable developments were president Trump's announcement (finally) that he would replace Fed chair Janet Yellen by appointing Jay Powell. Again, this had been widely expected as of late and since - as we recently wrote here - his policy views have been very similar to Yellen's, markets took it as another non-event. On the more market and economy relevant subject of the tax reform, far less progress was forthcoming and with the Trump administration coming under increasing investigative pressure over the Russian influence affair, many expect that very little real will happen this side of Christmas.

The more unnerving developments occurred in Spain, where, as widely reported, the Catalan conflict seemed to come to a head. However, the situation remained as relatively calm as the Spanish bond markets. This may have had to do with the fact that the Spanish government also announced that it would call for early regional elections in Catalonia. This would return the conflict resolution onto a democratically legitimised political path. This remains a watch and wait situation, but for the time being it feels that the risk of immediate escalation has been defused.

Finally, the more speculatively inclined investors where enthralled by the renewed meteoric rise of the trade value of the crypto-currency Bitcoin. Reaching $7,000 per coin over the week, its perceived value has now increased 7-fold since the beginning of the year and all virtual coins in circulation are equivalent to more than 100 billion US$. There are plenty of voices around warning that this pseudo currency is backed by not much more than speculative interest and the hope of internet finance enthusiasts that global crypto currencies may one day replace traditional national currencies. At the very least however, I would note that the recent value development has all the hallmarks of a market mania which inevitably will end in a value collapse at some point in the not so distant future.

For the full weekly, please click here.