Last week for the first time in more than 10 years, the Bank of England raised interest rates. The official bank rate has been lifted from 0.25% to 0.5%, the first increase since July 2007. It is likely to rise twice more over the next three years, according to Bank of England governor Mark Carney.
How did the markets react?
Although many analysts had predicted that the rate rise was priced into the markets, we still seen large swings during the day. The FTSE 100 index reached a weekly low of 7,444 shortly after midnight on the Thursday morning before spending its day charging up, reaching its peak shortly after 7pm at 7,570, a movement of 1.69%.
In a show of complete negative correlation, not unusual for the FTSE 100 and GBP, the Pound Sterling plummeted against the USD It was at its highest during the day just after 1am at 1.3299 before dropping in complete contrast to the FTSE before it reached its low, of which was its monthly low, at 1.3043, a drop of 1.96%.
As the rate increase was believed to be priced into the markets, the sudden movement in the charts may have caught a lot of traders out.
What does it mean for the economy?
“The policy dilemma facing Britain’s central bank is that it must balance surging inflation brought on by the weakened pound since the referendum, with the slowdown in the economy, dwindling consumer spending and declining inward investment” was the reasoning as to why the interest rate increased now. Just last week the UK’s GDP figure came out above forecasts at 0.4%, this was met with an air of cautious positivity across the markets as it was a healthy indication that the economy was growing above the expected rate. However, that figure is effectively artificial. The vast majority of spending is being done through debt vehicles such as credit cards, overdraft facilities etc. The consumer spending is actually starting to dwindle as people are having to repay these.
Research has shown that over one third of the UK’s population is living pay check to pay check and if money was tight, it will be even more so now. Mortgage repayments and other debt repayments will increase which, coupled with the widening gap of inflation in comparison to the increase in wages, will hit consumers even harder in the pocket. Is it good for savers? Of course an increase in the interest rate will, but it is worth noting that it is still only 0.25% and not all banks are preparing to pass this onto savers. Even if they were, £10,000 worth of savings would only gain an extra £25 per annum in interest.
Where does the market go from here?
It wouldn’t be surprising to see a lot of volatility and movement in the markets over the coming months with future rate increases on the cards, Donald Trump and the North Korean dispute and of course Brexit on the horizon.
I personally feel that the FTSE 100 index is artificially high and is being propped up by a cheap GBP as this is great for the large exporting firms based here. However, as the rate rises get introduced and start to hit people in the pocket along with the chance of an extremely messy Brexit, this could see the index dropping to potentially pre-referendum levels as we face the distinct possibility of a another economic crisis. The GBP rate will also have a number of factors coming into play but this is one that could go either way, I feel the messier the Brexit becomes, the weaker GBP becomes as it creates a huge air of uncertainty which is one thing the markets certainly don’t like.
Mat Clarke, InvestmentWatch UK