The Bank of England announced a fresh 0.25% interest rate increase at the meeting at lunchtime today. This takes the base rate here in the UK to 1%. Despite rate hikes usually being bad news for the stock market, the FTSE 100 actually rallied on this announcement, and is currently up 1.26% on the day. What’s going on here and what should I do?
Why high rates are usually bad for stocks
Traditionally, higher interest rates are seen as bad for the stock market. The reason why central banks increase rates is to try and stem rising inflation. High inflation is often caused by economic activity, with high demand for products and services. So raising interest rates does try to put a lid on demand, which isn’t great for businesses.
Higher interest rates are also a problem for large corporates in the FTSE 100 because they make debt more expensive. There are very few companies that don’t have sizeable debt on their balance sheets, enabling funding for expansion or other needs. The higher the interest rate, the more expensive it is to issue new debt, via bonds or other forms of borrowings.
Why the stock market is rallying now
After noting the above, it might seem strange at first glance as to why the stock market is rising today and not falling. The main reason is that the forecast for future rate moves has decreased.
The Bank of England’s committee noted that it’s forecasting a sharp slowdown in economic growth at the end of this year. This is partly due to high energy prices. It also sees unemployment rising to 5.5% over the next three years. Therefore, raising interest rates much higher than currently wouldn’t be a smart move.
There could be some further hikes this year, but not by as much as previously thought. This is why the stock market has actually taken the meeting as a positive sign with regards to interest rates. It’s like me expecting to pay £120 for a restaurant bill but when the bill comes it’s only £80. It’s still an expensive meal, but not as bad as I was expecting!
What I’m doing now
As a long-term investor, I try to look past day to day moves in the markets. Swings are normal and so I don’t want to my vision to be clouded by something that might not be relevant in a few months’ time. However, with this kind of event, the forecasts for the future are impacting my investment choices now.
If we’re going to see economic activity slow, I want to increase my allocation to defensive stocks. These include utility companies like National Grid. This also includes sectors with stable demand, such as alcohol and tobacco stocks. For example, I like Diageo as an attractive stock in this area.
I’m also thinking about buying stocks from the market that don’t have much exposure to the UK. This could help me to diversify my overall portfolio from just being UK-focused. For example, I recently wrote about why I like US tech stocks including Intel and Activision Blizzard.