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Interest Rates Finally Rise

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Summary

Era of falling interest rates draws to a close but they will remain very low for years to come

2 min read

They finally did it! 10 years on from the last one, and 9 years since the slashes at the start of the Great Financial Crisis, the Bank of England raised U.K. interest rates from 0.25% to 0.5%. 

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Indeed this is the first time Governor Mark Carney, who was Head of the Bank of Canada before, has ever raised rates. This was entirely expected by markets as Mr Carney had been warning for several months. Is this the start of an ever-rising cycle of rate rise to come, a ‘normalisation’ of policy after a period of historically low rates?

We think not. Whilst we are clearly coming to the end of the period of extremely cheap money globally – the Fed has raised rates 4 times in 2 years for example – Mr Carney’s comments were dovish on the future path of interest rates. He did say that rates would rise in over the next few years, specifically he thought two rises in 3 years would be appropriate to hit the 2% year-on-year inflation target

“Is this the start of an ever-rising cycle of rate rise to come, a ‘normalisation’ of policy after a period of historically low rates? ”

However, he shaped this rise as an un-doing of the emergency rate cut in August last year, given the UK economy has been stronger than many commentators had predicted. He played down worries about inflation, which at 3% is well above their 2% target, by saying the recent rise was mostly transitory due to the weakness of Sterling and this will normalise in coming years. And finally the Bank clearly have worries about the future strength of the UK economy and noted concerns about the low growth of UK productivity (output of goods and services per worker) and, inevitably, the uncertainty about the UK’s trading relationship with Europe.

During a rising rate environment government bonds tend to suffer. In client portfolios we have, over the last few years, steadily reduced our government bond exposure into less interest rate sensitive investments. However, we are less worried about the impact of rate rises than we are about the low returns possible on these assets. At current levels government bonds provide investors with a nominal annual return of 1.3% for the next 10 years, this quickly turns negative when inflation is considered. We therefore see the main role of government bonds as diversification tools in case other assets classes turn down.

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We offer discretionary investment management to individuals and their families, and to charities. We take a long term approach to investing and we believe this gives us an advantage in a world where markets and media are increasingly focused on short term news.

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