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.
FORGET your stocking. The Bank of England has delivered the biggest surprise of all this Christmas, by raising interest rates from their current record-low levels of 0.1% up to 0.25%.
Yesterday’s move indicates how seriously the Bank takes the recent acceleration of inflation, with UK consumer prices shown to have risen an eye-watering 5.1% over November.
On the face of it, raising rates seems the obvious move. It’s the traditional tool used by central banks to curb inflation; with inflation on the rise, rates should follow. The last time inflation hit 6%, a figure the Bank has forecast for next year, rates were over 10%.
Two issues complicate that picture. First is the unique character of today’s inflation; second is concern over the lasting damage Omicron may wreak on the economy.
We tend to think of inflation as the result of rising demand pushing prices higher. Raising the cost of borrowing (raising interest rates) means people have less money to spend, which sees demand fall back in line with supply.
The issue is that today’s inflation is less a problem of excess demand and more one of insufficient supply. A rise in UK borrowing costs won’t compensate for labour shortages or lower shipping costs, for example.
That’s not all. The risk is not only that raising rates fail to provide the solution, but that they also exacerbate the problem.
The emergence of Omicron means the Bank is no longer sure where the main threat lies: whether the new variant will push prices further (more people isolating means more supply chain disruption), or whether it stagnates growth like the virus did back in early 2020.
Evidence of the latter is already emerging. People entering into “voluntary self-isolation” is bad for growth. Any further restrictions would be even worse. In a scenario where growth does stagnate, increasing the cost of borrowing could pour fuel onto a fire that engulfs the UK’s economic recovery.
Stuck between a rock and a hard price, the Bank has decided the risk of prices getting out of hand is greater than the risk to growth. But it clearly has doubts.
Such is the complexity of the situation that the Bank raised rates on the same day it cut its fourth quarter growth forecasts. That’s like the opposite of having your cake and eating it.
All this means different things for different investments.
Rising rates will be reflected in higher rates on mortgages, potentially putting added pressure on households which are already seeing the cost of living soar.
If you want to find out more about how rising interest rates affect your investments, my colleague, Ed Monk, wrote a handy overview here.
Or watch this video for more on the negative effects of inflation.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. 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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