Bank of England misses interest-rate boat

Tom Stevenson
Tom Stevenson
Fidelity Personal Investing13 June 2018

Another day, another set of disappointing UK economic data. This morning’s inflation number was flat at 2.4% for May against expectations of 2.5% or higher.

Why’s that bad news, you might well ask? Surely lower inflation is a good thing, isn’t it?

Well it would be, were it not for the fact that the recently soaring oil price gave the latest prices data a big upward shove. Petrol was 3.8% higher in the latest month. Strip out higher fuel costs and the rest of the economy is clearly much weaker than we thought.

The inflation figures come hot on the heels of yesterday’s wage growth number, which was also lower than expected at 2.5%. That’s particularly disappointing when viewed in the context of the lowest unemployment rate for 40 years.

If wages can’t grow when employment is running at record levels then when can it? It suggests that weak productivity, the public sector pay cap, a reduction in collective bargaining and the rise of part-time working and zero-hours contracts are undoing the good work of years of monetary stimulus.

Even before the employment data, we had disappointing figures on manufacturing on Monday. All is not well with the British economy.

None of this will come as a huge surprise when you consider the global economic and domestic political backdrop. President Trump’s growing protectionism is obviously aimed primarily at China, but it is America’s friends which seem to be caught in the crossfire. And on top of that the latest developments in the Brexit soap opera are keeping British business’s nerves on edge.

A lack of investment, stagnant wage growth and weak sentiment are a bad combination as the Bank of England prepares for next week’s rate-setting meeting.

In reality, June’s meeting is a foregone conclusion. There will be no rate hike this month. The next probable date for the Bank to move is August, when the Inflation Report provides the statistical back-up to justify a move. Even a summer rate-hike now looks no more than a 50:50 bet as rate-setters once again err on the side of caution.

With the UK’s retail sector on the ropes and consumers struggling to keep their heads above water in real-inflation adjusted terms, there is little incentive for the Bank to take any risks with the recovery. Rates may well not rise before 2019.

The problem with that softly-softly approach, however, is that when the next downturn does arrive there will be no dry powder in Threadneedle Street. If interest rates remain at what we used to call ‘emergency’ levels, then the Bank will be powerless to intervene to stimulate activity when it needs to.

The moment to act may well have passed. The interest-rate ship has sailed.

What does this mean for investors? In the short-term it is probably good news for the UK’s main index. The FTSE 100 is such an international market that a weak pound (the inevitable consequence of a cautious Bank of England) tends to boost profits on average for Britain’s leading companies.

In the longer-term it makes the case for remaining exposed to higher-yielding assets than cash. With the FTSE 100 index yielding around 4%, and many of its leading stocks paying an even higher income, it remains an attractive hunting ground despite the weak economic backdrop at home.

The Select 50 offers a broad choice of UK funds from smaller company specialists like the Franklin UK Smaller Companies Fund and the Threadneedle UK Mid 250 Fund to equity income funds like the JOHCM UK Equity Fund and Fidelity’s Enhanced Income Fund.

The outlook for the UK market is just one topic that’s covered in depth in my latest Investment Outlook which I’m launching tomorrow with the usual live online Q&A session. This will be at the new time of 12 noon. Join the conversation at www.fidelity.co.uk/investmentoutlook.


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