The decision by the Bank of England to increase interest rates by 0.25% was widely expected and is unlikely to have a major impact on your financial future. GDP growth numbers and the general performance of the economy in terms of employment levels have been relatively robust of late. Alongside rising inflation, this meant that it was logical for policymakers to increase interest rates for the first time in a decade.
Initial impact
Of course, interest rates remain close to historic lows. They are at the same level as they were in the aftermath of the credit crunch. As such, the UK still has an ultra-loose monetary policy which is highly accommodative in seeking to generate higher levels of economic activity. As such, the effect of what is a small rate rise on GDP growth, employment levels and inflation may be somewhat limited.
In fact, it could be a case of ‘business as usual’ in these areas, as well as in the outlook for assets such as shares. When coupled with the inevitable time lag of the impact of a higher rate, this could mean that the initial impact largely goes unnoticed.
Future prospects
However, perhaps the most important aspect of the Bank of England’s decision was the way it chose to communicate the rate rise. It was not sold as the start of a period where policymakers will seek to raise rates at every available opportunity. Instead, the Bank was extremely cautious and made it clear that it does not anticipate a significantly tighter monetary policy over the medium term.
One reason for this could be the effect of Brexit. It has caused uncertainty regarding the UK’s economic outlook to increase. Consumer confidence is at a relatively low ebb and business confidence is also relatively weak. Therefore, the Bank of England is mindful of the potential for rate rises to choke off the performance of the wider economy over the medium term.
Medium-term impact
A slowly-rising interest rate could be good news for investors. It should mean that the pound remains relatively weak, which could provide a boost to mid and large-cap shares. Many of them are international companies which report in sterling, and a weaker pound may lead to a positive currency translation that could boost their profitability and valuations. Similarly, a weaker pound may be good news for exporters, since they could become more competitive.
However, a slowly-rising rate may mean that the UK experiences a prolonged period of higher inflation. This may squeeze the performance of UK-focused companies, and mean that investors here may wish to buy stocks that have at least some international exposure. It also means that dividend stocks may become more popular, since obtaining a real income return could become even more challenging.
As such, while the impact of the interest rate rise may be limited, the decision to raise rates slowly could push investors towards international stocks with high dividend yields.