Minutes of the Bank of England (BoE) Monetary Policy Committee (MPC) meeting on 14 June 2017 were published on 15 June, revealing the vote to retain the Bank Rate at 0.25% and to maintain the current corporate bond and UK government bond purchases at £10billion and £435billion respectively.
What came as a surprise though, were the three members voting for a rate rise, citing inflation concerns. This is the strongest support for a rate rise since prior to the financial crisis. This is tempered somewhat by the views of the other five members, where concerns over slowing consumer demand and Brexit uncertainty were noted.
Nonetheless, the pound rallied versus the dollar on what markets saw as an increased probability of a rate rise over the next 12 months. Mark Carney initially further cooled expectations in a speech, saying now was not the right time to raise interest rates. However, on 28 June he commented that the debate for a rate rise is building, resulting in sterling rallying and bonds selling off.
The mixed messages remind us of Pat McFadden MP’s comments in 2014, likening the Bank of England’s forward guidance to an “unreliable boyfriend”. In reality, the mixed messages being given reflect the mixed signals from markets: is wage growth coming through?; will consumer spending continue to slow?; are we starting to see the negative effects of Brexit?
The reaction of markets has been somewhat predictable. Sterling rises and falls as hints for rate rises or not respectively are given. Similarly, gilts sell off during signalling of rate rises and vice versa. Recent weeks have seen a more clear direction; long gilts are down 1.5% in June and Sterling is up 0.2% against the dollar, having rallied nearly 5% year to date.
UK investors measuring unhedged overseas equity investments will see returns negatively impacted, all else equal, as sterling strengthens. The UK’s FTSE All Share is also seeing a high negative correlation with sterling. This is driven by the high proportion of overseas earnings within the FTSE 100 (the top 100 companies), as a stronger pound affects overseas competitiveness and reduces the value of overseas earnings.
What should investors do?
We’ve learned better than to try to call if now is the turning point in monetary policy (i.e. will rates start to rise). What we do believe is as follows:
- The MPC is likely to be tolerant of higher than target inflation unless they have material concerns on sustained wage growth.
- Markets will continue to be volatile in response to the sort of signals discussed above.
- If concerns over consumer spending and Brexit impact escalate, the MPC stands ready to remain in accommodative mode – i.e. lower for longer.
Investors should note alternative opportunities to equities if volatility is a concern, particularly noting the strong returns from equities over recent years.
Where pension schemes are considering increases to hedging, its cost has fallen in recent weeks and it may get cheaper but day to day volatility remains high. Phasing changes diversifies short term timing risk and avoids the generally fruitless task of trying to call the optimum time.
Where there are large exposures to overseas currency, investors should consider moving to a more neutral position. As described above, UK equities are not generally providing that protection so explicit hedging of overseas equities should be considered.
We wait with interest the next vote, to see whether the hawks fall back into line or whether some of the doves display hawkish tendencies.
Mark McNulty, Managing Director, Investment Solutions | T: +44 20 7528 4025 | E: email@example.com
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