With ‘Super Thursday’ proving to be something of a let-down as a result of its big build-up, investors could be forgiven for losing interest in when interest rates will rise. After all, just when it seems as though they are about to rise, the idea of increasing them to 0.75% or even 1% seems to be kicked into touch.
Of course, it’s little surprise that they are still at 0.5%. Certainly, the UK economy is performing much, much better than it was a few years ago and, with wage growth now outstripping inflation, consumer spending levels should be given a boost. Furthermore, the banking sector is moving from strength to strength and, were it not for PPI claims, would be in even better shape.
However, the problem is that inflation remains stubbornly low. Part of the reason for this has been falling oil prices, while a strong sterling has reduced the relative cost of imports, too. As a result, the Bank of England is unlikely to raise interest rates imminently since it could push the UK into a prolonged period of deflation, which would be likely to hurt the economy to a greater extent than high levels of inflation.
Despite this, interest rate rises are coming. In 2016 they are likely to rise and, as history shows, things can change very quickly when it comes to the performance of an economy. Therefore, they may rise at a much faster pace than is currently expected – especially if the UK continues to perform well economically.
As such, it seems logical to be prepared for interest rate rises and investors can do this through the types of assets that they choose to hold in 2016 and beyond. Clearly, bonds are likely to become a less appealing asset, since their price moves inversely to interest rates. That’s because their coupon payments are fixed and, in order to compete with higher interest rates, their yields must rise and this means falling prices. Similarly, for property investors the future may not be so profitable, since a rising interest rate may dampen demand for mortgages and cause the capital growth that has been a feature of recent years to come to an end.
For investors who hold considerable cash balances, higher interest rates are clearly welcome news. They should be passed on by lenders and allow savers to (at last) received a more appealing return on their investment. However, if inflation does pick-up (which the Bank of England is expecting to take place over the medium term) then the real return on cash could become negative.
Although shares are likely to be impacted negatively by a rising interest rate, the full effect of it may be somewhat subdued. That’s because, while investing will become relatively less attractive versus saving as interest rates rise, the FTSE 100 remains relatively good value and its constituents are likely to continue to perform well as the global economy goes from strength to strength. Therefore, its performance should be relatively strong compared to the other major asset classes, thereby making the present time a good opportunity to invest in good value companies with modest debt levels and which are expected to post strong growth figures over the medium term.
