When will UK interest rates rise again?
The Bank of England's ("BoE") Monetary Policy Committee ("MPC") meets next week. At that meeting, they will be publishing their latest Quarterly Inflation Report which gives investors further clarity on the outlook of the UK economy. Just a month ago, the market implied that there was a 95% chance of a rate rise at this meeting but as I write, this probability has moved down to 10%. Over the last month we have seen a succession of economic data for March that has come in weaker than expected. Inflation, consumer credit, industrial production, construction output and retail sales were all below expectations. The interview given by the Governor of the BoE casted doubts on the timing of the next rate rise. It is possible that the extreme weather at the beginning of March may have impacted economic data, but the central bank will want to make sure this is not a sign of a softer growth to come before moving rates higher again. From a labour market perspective, unemployment is low and we have seen some sign of increasing wage growth but inflation, while lower than it was, remains above the MPC 2% target. The first data for April came out earlier this week in the form of Purchasing Managers Indices where both the manufacturing and services were below market expectations.
We will have to watch the data closely as we move into the summer months to see if we bounce back from the March disappointment. The statement and inflation report following the MPC meeting on Thursday may give us a clearer idea of the MPCs thinking on the timing of the next rate rise. However given the recent data we may have to wait for the next inflation report at the start of August before they have the confidence to move. Markets indicate that even the August meeting is only a 52% chance of a rate hike. For the wider markets the exact timing of a rate rise is less important than the pace and long term expectations for rates. In this regard we expect the bank to continue to characterise interest rate rises as "gradual and to a limited extent".
After the volatility of the first quarter what do corporate earnings tell you about the health of the US private sector?
In the first quarter of the year we saw some wild swings in the market. The S&P 500 index started the year by moving up 7% then fell 10% but ended the quarter only losing 1% after dividends are taken into account. Concerns centred on fears interest rates would rise more quickly than anticipated and the announcement of trade tariffs by Donald Trump. Trump's attacks on the tech sector and Amazon in particular added to the uncertainty. At times of political noise and market volatility it is sensible to focus on what is happening on the ground. 80% of the companies in the S&P 500 index have reported earnings for the first quarter of the year. The numbers are broadly very positive with earnings up 23% and sales up 8%. Earnings were expected to grow due to the recent tax changes but 76% of companies exceeded their predictions. Sales growth was also ahead of expectations. All other things being equal this would have been very positive for the US equity market. However after the big rally last year and the volatility of the first quarter, so far in the second quarter the market as whole has made little progress. We expect interest rates to rise two or three times more this year but if the economy grows and company earnings and sales maintain this level of growth then this should not be a concern. Political noise will continue and we expect more periods of volatility but we should remember that in buying equity markets we participate in real businesses. If the first quarter results are our guide to the real world we can remain positive in the long run.
Source: Bloomberg, 4th May 2018
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