Yesterday’s news of a further base rate hike, when it had been widely expected that the rate rise would not materialise until February, caused a knee-jerk reaction that wiped out all the gains the market had made that day.
On a more sober reflection, and helped along by strong commodity prices, a strong opening the other side of the pond on Wall Street and some heavy buying of Vodafone, the FTSE100 more than recovered its poise to finish the day nearly 70 points up.
What, if anything, can be drawn from this reaction?
It has often been said that fear and greed drive markets. Fear of the unknown is something with which the market is extremely uncomfortable, changing as it does forecasts, prospective earnings and the general outlook. The initial reaction to such news, when not widely expected, is to assume the worst in the short term and then let the market find its own level in the following hours and days.
Of course, the direction of interest rates was not the surprise, rather the timing. This was the first interest rate rise in January for 10 years, but the logic behind it is compelling – with hindsight, there was no reason why the Monetary Policy Committee (MPC) should have waited another month. When the minutes of this meeting are released, they will be subject to much scrutiny for any indications of further rate rises, or indeed indications that this rise may have done the trick.
The major concerns seem to be inflationary. The latest figure available is 2.7%, against the Government’s 2% target, and some fear that next week’s Consumer Price Index (CPI) could contain some nasty numbers – bear in mind that the MPC will already have had access to these numbers and, as such, this may have been a major factor in their decision to have raised rates now. At the 3% level, the MPC must write a letter of explanation to the Chancellor, something it has not had to do for some considerable time. Another inflationary pressure is wage rises, since the months of January and February are traditionally pay negotiation times. With household bills at relatively high levels, there are concerns that wage increases may need to be inflation busting.
The strength of the housing market has shown few signs of abating, with the desire to borrow still in full swing, and a number of recent trading statements from the retailing sector has very much underlined that the Christmas carnage which some were forecasting did not happen. Whether the shopper in the High Street is borrowing further to finance this expenditure remains to be seen, and as the full-year banking reporting season gets into full swing next month, this may provide a further clue.
On this occasion the MPC has shown that it has not lost its teeth, and that it is prepared to take swift and decisive action if it considers that the wider economy needs cooling down. On the basis that it is generally accepted that the full effects of an interest rate rise can take anything up to six months to wash through, the immediate impact of this announcement was more psychological than actual. Nonetheless, it has resulted in the economists reaching for their number crunching machines as they ponder whether there is more of the same to come.
In the meantime, investors should avoid being drawn into market knee-jerk reactions – investment is a medium to long term business and, whilst the market is digesting the latest piece of economic or corporate news, patience is often a virtue.
If you’d like to read more free research, comment and analysis from me and the rest of my colleagues at Hargreaves Lansdown please visit our website at www.hargreaveslansdown.co.uk
Richard J Hunter
Head of UK Equities
Hargreaves Lansdown
www.hargreaveslansdown.co.uk