Fast reading:
- The Bank of England (BoE) raised interest rates to 5% on Thursday, lifting rates to levels not seen since April 2008 in the aftermath of the Global Financial Crisis (GFC).1
- The latest official data released on Wednesday showed UK headline inflation refused to budge in May – sticking at 8.7%, despite hopes it would drop.
- Core inflation, which strips out food and energy prices, rose to 7.1% in May, reaching its highest level in 31 years.2
The latest hike, up by a surprise half point to 5%, comes as the central bank faced increasing pressure to take more decisive action against inflation, following the release of CPI data for May. Inflation in the UK remains well above the central bank’s target of 2%, as shown in Figure 1 below.
The BoE defied market expectation of a 0.25-point increase, signalling a more aggressive approach to tackle the inflation challenge. The bank has been criticised so far for its insufficient, ‘too little, too late’ response to inflation, with policymakers facing accusations they had misjudged the extent of tightening required to keep a lid on soaring costs.
Orla Garvey, Senior Fixed Income Portfolio Manager at Federated Hermes Limited, believes the latest move from the bank has allowed them to claw back some much-needed credibility.
“This decision, combined with the 7-2 voting split and minutes which also put suitable weight on both current inflation and forward-looking indicators, has sent a strong message that the Bank of England will keep pushing back against inflation. Given that core inflation is likely to remain flat for the next few months, this was an important signal to send,” she says.
Figure 1: Dug in - CPI inflation to May
The BoE maintains its stance that inflation will come down over the months ahead, but it has not ruled out raising rates if prices continue to climb.
Figure 2: UK interest rate reaches highest level since 2008
This decision has sent a strong message that the Bank of England will keep pushing back against inflation.
Tug of war
The interest rate picture in the US, coupled with strong gains in the stock market, has resulted in something of an ‘even playing field’ for investors. The case for bonds, cash and equities seems, for the first time in a long time, evenly matched, as the earnings yield for each asset class hover at a similar level (Figure 3).
Figure 3: A more even playing field for equities, cash, and bonds
Source: The Financial Times, Bloomberg, as at 18 June 2023. Past performance is not a reliable indicator of future results.
Despite the prospect of higher interest rates – the usual headwind for growth stocks over their value-focused counterparts – Geir Lode, Head of Global Equities at Federated Hermes Limited, is upbeat on the prognosis for earnings growth, with, he believes, US technology and communications stocks set to lead the charge.
“We are firm in the belief that the strong earnings growth in the tech and communications sectors will eclipse the dampening effects of higher borrowing costs,” he says.
However, Lode notes that with the market’s inherent dispersions, not all sectors are created equal, and the picture remains varied, as projections for sectors such as oil, materials, and healthcare suggest more tempered earnings growth.
“While we still expect the direction of travel to be upward, the pace of ascent appears much more modest when compared with the robust growth forecast for the tech and communications sectors,” he says. “As the year progresses, it will be intriguing to watch this tug of war between surging earnings and climbing interest rates.”
For more insights on interest rates, please read last week’s market snapshot.
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1The Financial Times, as at 22 June 2023.
2 Office for National Statistics, as at 31 May 2023.
