Schroders Quickview: As UK growth rebounds, are rate rises on the horizon?
Following a rebound in UK GDP, Schroders Senior European Economist & Strategist Azad Zangana expects the Bank of England to raise interest rates in early 2016 and at a faster pace than markets anticipate.
- Real GDP growth picked up to 0.7% in three months to June
- Industrial production powers GDP recovery
- Economic backdrop conducive for early 2016 rate rise
UK rate rise on the cards
The latest GDP figures suggest that the economy is performing strongly and should continue to create more jobs, putting upward pressure on wages.
With growth having rebounded in the second quarter and inflation forecast to rise above 1% in 2016, we believe the Bank of England (BoE) looks set to raise interest rates early next year.
We do not think the Monetary Policy Committee (MPC) will want to explain to the public why it needs to raise interest rates, but at the same time, the Governor is writing letters to the Chancellor to explain why inflation is too low. It would be a communication nightmare.
The current annual rate of the Consumer Price Index (CPI) inflation is zero. This is significant as the BoE’s inflation target is set as a 1% upper and lower band around a 2% central target.
We forecast CPI inflation to rise above 1% at the start of 2016, which should give the MPC cover to start hiking.
Where will a rate rise impact asset classes?
Once the BoE starts to hike rates, we expect it to tighten at a faster pace than markets are currently pricing, which should put more upward pressure on sterling.
Further rises in the pound are likely to have a negative impact on UK equities, especially for companies that have a high reliance on overseas earnings.
Of course, for gilt investors, higher-than-expected interest rates should cause gilts yields to rise and prices to fall.
The UK GDP data you need to know:
- Real GDP growth picked up to 0.7% in the three months to June, an improvement compared to the 0.4% growth recorded for the previous quarter.
- On a year-on-year basis, growth slowed from 2.9% in the first quarter to 2.6% in the second.
- The pickup in activity was driven by an improvement in industrial production, where growth in the mining and quarrying industry picked up sharply to 7.8% quarter-on-quarter, compared to -0.5% previously.
- Manufacturing, which is a sub-sector of industrial production, contracted over the quarter (-0.3%), highlighting the difficulties manufacturers face as the strength of sterling hits export demand.
- The services sectors also improved, growing by 0.7% compared to 0.4% previously, with business services and finance showing the greatest improvement (0.8%, up from 0.1%).
- Otherwise, construction activity was flat during the period
This communication is marketing material. The views and opinions contained herein are those of the named author(s) on this page, and may not necessarily represent views expressed or reflected in other Schroders communications, strategies or funds.
This document is intended to be for information purposes only and it is not intended as promotional material in any respect. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Schroder Investment Management Ltd (Schroders) does not warrant its completeness or accuracy.
The data has been sourced by Schroders and should be independently verified before further publication or use. No responsibility can be accepted for error of fact or opinion. This does not exclude or restrict any duty or liability that Schroders has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Reliance should not be placed on the views and information in the document when taking individual investment and/or strategic decisions.
Past Performance is not a guide to future performance. The value of investments and the income from them may go down as well as up and investors may not get back the amounts originally invested. Exchange rate changes may cause the value of any overseas investments to rise or fall.
Any sectors, securities, regions or countries shown above are for illustrative purposes only and are not to be considered a recommendation to buy or sell.
The forecasts included should not be relied upon, are not guaranteed and are provided only as at the date of issue. Our forecasts are based on our own assumptions which may change. Forecasts and assumptions may be affected by external economic or other factors.
Issued by Schroder Unit Trusts Limited, 31 Gresham Street, London, EC2V 7QA. Registered Number 4191730 England. Authorised and regulated by the Financial Conduct Authority.