Important information: The value of investments and the income from them, can go down as well as up, so you may get back less than you invest.

NO surprises for anyone today, as the Bank of England raised interest rates by 0.5%. The last time rates were raised this much in a single move was in 1995. At the time of writing, two-year gilt yields (1.8%) and the pound (1.21 versus the dollar) are little changed on the day1.

Today the Bank reaffirmed it expects inflationary pressures to dissipate over time, and that “commodity prices are assumed to rise no further”. However, it also recognised there remain “exceptionally large” risks to its forecasts, owing to both external and domestic factors2.

At 1.75%, the Bank Rate remains paltry compared to inflation close to 10%, suggesting the Bank is content to see markets and the economics of supply and demand doing a good deal of the heavy lifting when it comes to fighting inflation.

The last time inflation was as high as it is today – in early 1982 – interest rates were about 14% although, admittedly, overall economic conditions were very different from today3.

Markets, on the other hand, seem to be signalling the Bank has already – or is about to – move too far. Gilt yields are now broadly similar for maturities from two out to ten years, consistent with a flat economy and inflation falling back towards trend4.

In any case, interest rates are a rather blunt instrument given current economic circumstances. International commodity prices coupled with disrupted global supply chains after the pandemic are both substantially beyond the Bank’s control.

In a worst-case scenario, higher interest rates drive the economy into a recession without having a significant effect on prices.

The risk of a recession in the UK is heightened by the economy’s heavy reliance on consumer spending. Anything that influences the consumer’s ability or propensity to spend also affects economic growth expectations.

That makes raising interest rates a dangerous game. Already there are signs of consumers going on strike, with sales of white goods and homeware falling and a switch to cheaper brands underway5.

Meanwhile, surging mortgage interest costs appear to be finally wiping froth from the housing market. UK house prices rose by a meagre 0.1% last month6.

House price falls could trigger a negative ‘wealth effect’, further dragging down consumption.

We’re living in a time of volatile expectations. Views differ wildly about where the economy is headed next, with talk of yet higher inflation, a soft landing for the economy and even the possibility of a period of deflation if rates go too high. All these scenarios look possible.

In such uncertain times it makes sense for investors to keep a cool head and a diversified portfolio of investments to help them stay on course to achieving their long-term goals.

1 Bloomberg, 04.08.22
2 Bank of England, 04.08.22
3 Bank of England, August 2022
4 Bloomberg, 04.08.22
5 British Retail Consortium, 12.07.22
6 Nationwide Building Society, 03.08.22

Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. There is a risk that the issuers of bonds may not be able to repay the money they have borrowed or make interest payments. When interest rates rise, bonds may fall in value. Rising interest rates may cause the value of your investment to fall. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.

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