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Preparing for rate rises – why cash is not the answer

June 2018

Tags: Macro Economics

The Governor of the Bank of England, Mark Carney backtracked from previous guidance for a rate hike in May 2018 amid economic uncertainty. Still, most observers reckon it is a matter of when, not if, the Bank will look to increase rates from the current level of 0.5%. Many still think the UK will see interest rates rise in 2018.

How should you prepare? Well, the pace of any increases are likely to be sluggish, so the rates available on cash deposit accounts, which are largely priced according to the Bank-set rates, will remain a long way short of inflation. This means if you keep your money in the bank its spending power will be eroded.

There is, therefore, a strong argument for putting your money to work in the markets, provided you are prepared to accept the associated risk of capital loss.

Even if they remain at historically low levels, the direction of rates influences the way different asset classes perform.

Higher rates are sometimes seen as negative for stocks and shares as they increase the return from cash and therefore create larger attractiveness of lower risk assets like cash and bonds. However, in the US, incremental increases in rates, something which the country’s Federal Reserve commenced in December 2015, have been no obstacle to its stock market indicies advancing to record high levels.

Historically, some areas of the market have performed better than others when rates are rising, and this can help inform some potential investment ideas.

A likely result from higher rates is a stronger pound. The increased return on offer from sterling-denominated assets attracts foreign investment, inflating demand for and the value of the currency.

This could be good news for UK mid-caps which typically have a more domestic focus than their peers in the FTSE 100 index.

The table below shows how the UK large cap and mid-cap indicies have performed during previous rate hike periods.

Source: Shares Magazine, Thomson Reuters

Investment trust JPMorgan Mid Cap (JMF) provides exposure to this area of the market.

On a sector level, the biggest beneficiaries from rising UK base rates are likely to be the big importers and the UK-dominant banks like Royal Bank of Scotland (RBS) and Lloyds (LLOY). It should be good news for retailers, which source a lot of products from overseas, although they face the risk that consumers have less spare cash to spend in the shops if their credit card, loan and mortgage repayments are pushed up.

Retailers, which buy goods from overseas include Next (NXT) and Primark-owner Associated British Foods (ABF). The cost of products, in sterling terms, will be reduced, which should allow for higher margins and increased earnings.

Interested in behavioural economics and how you can apply these principles to trading?

Check out the first article in our three part series where behavioural psychologist Paul Davies opens the bonnet on our personal trading engine—our brain—to uncover the secrets of how we act as individuals.

Read more

How can you help your money grow in the face of inflation and low interest rates?

ETF Securities explains how investing in an ETF that covers Gold and other precious metals can help.

Read more

Writer: Tom Sieber Tags: Macro Economics

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Selftrade does not provide investment advice. This article is the authors view and is not the view or opinion of Selftrade and Selftrade accepts no liability for any loss caused as a result of the use of this information. The opinions expressed are those of the author at the time of writing and should not be interpreted as investment advice.

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