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Was the Bank of England right to raise interest rates?

The Bank of England has raised interest rates for the second time in a decade, increasing the base rate to 0.75%. Although the move was expected by financial markets, the wisdom behind it is up for debate.

The Monetary Policy Committee (MPC) voted unanimously to raise its benchmark interest rate by 25 basis points. In June’s meeting three members voted to keep the base rate at 0.5%. They seemed to have changed their mind over the last month, even though the case for hiking rates has gotten weaker, not stronger.

The Bank and its Governor are in an unenviable position. They are having to manage a combination of low interest rates, low unemployment and wage growth, sluggish economic growth, declining inflation and massive policy uncertainty around Brexit.

Most Central Banks want to normalise monetary policy off the stimulative gauge the global economy has been set on since the financial crisis. The Bank of England is no different, but the economic data hasn’t made it an easy transition for them.

And then there’s the behavioural aspect; it’s unlikely Governor Mark Carney enjoys his “unreliable boyfriend” monicker – even if he’s trying to tune it out. It doesn’t require too much cynicism to see the 9-0 vote as some sort of message.

Many had expected the MPC to deliver a ‘dovish hike’ that raised interest rates but talked down the prospect of future interest rate hikes. Yet the commentary the move was packaged in seems quite neutral, with the MPC saying: ‘Any future increases in the Bank Rate are likely to be at a gradual pace and to a limited extent.’

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How did markets react?

Sterling initially strengthened on news of the hike, but sold off quite sharply soon after. This could be interpreted as the market thinking the MPC has made a mistake in tightening monetary policy.

Although this prompts the question that if you thought interest rates would rise, but believed this to be a bad idea, wouldn’t you have sold sterling yesterday?

For now, the will they/won’t they excitement seems to be over for another good few months. The market doesn’t expect another rate hike until well into 2019, and we at Moneyfarm think that’s  a reasonable assumption.

It would take a really sharp macro deterioration for the MPC to consider a cut. But, as ever, they’ll be driven by macro data and policy.

As Moneyfarm portfolios have a limited exposure to the UK, weaker sterling should support our non-sterling exposure, especially in higher risk portfolios.

Inflation-linked bonds should hold up fairly well. The current market environment globally has a “risk-off” tone, although that’s more to do with persistent trade worries than UK interest rates. In that environment, our relatively conservative positioning should give us some protection.

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