Bank of England action: the ATI view

This article was first published by Alliance Trust Investments on 10 August 2016.

Views from ATI's key fund managers on the potential impact on major asset classes of last week's Bank of England decision to cut interest rates and increase quantitative easing.

On Thursday 4 August the Bank of England announced that it would cut its base interest rate from 0.50% to 0.25% - the first time it has altered interest rates since 2009. In addition it has pledged to buy up to £70 billion of bonds through its quantitative easing programme. Here we want to share a brief overview of our views on the potential impact on major asset classes:

UK Equities:

We believe that this decision will ensure that sterling will remain weak, benefiting those British companies that earn in US dollars. It will also be supportive of housing and consumer spending, but short term these factors are driven more by sentiment and at the moment this looks poor. Losers include banks and insurers given current long, flat and low yield curves.

Over the long term, this is the right medicine for the UK economy; however there is now only one more spoonful of medicine left before rates are at zero. Given recent weak economic data, there is also likely to be additional government stimulus for the house building and infrastructure sectors this year.

Global equities:

Global stock markets had largely already priced a rate cut at the Bank of England in, and so once again sterling is likely to bear the brunt of the decision. Overall we don’t believe that it will make a huge difference to the global economy. In terms of fresh quantitative easing, stimulatory/unorthodox monetary policy may have reached the limit of its effectiveness; however it will lend further support to equities and other risk assets.

The issue is that markets are now anticipatory, rather than reactionary, and as Mark Carney has been flirting with a rate cut since the Brexit vote happened in June, they expected it. The pressure is now on the Bank of England to deliver something, if only to bolster investor confidence and reassure markets that they are standing by with support. Having said all of this, fiscal policy may be the real lever that policy makers are preparing to pull.

European equities:

European markets will continue to remain focused on political risk, both at the national election level and on the future shape of the European Union, as well as on the not unrelated issue of how to resolve Italy’s banking problems within the existing rules.

It’s clear that a degree of rate cut had already been baked in by the markets given weak PMI data over the last few weeks and we feel this action by the Bank of England is what is needed. However, the run the FTSE100 has enjoyed post-Brexit means the market response is likely to be muted. As further stimulus raises questions around ‘what next’, small cuts of this 0.25% variety are marginally positive and unlikely to spook investors.

Fixed income:

From a fixed income perspective this decision significantly reduces the risk that UK government bonds (gilts) will suffer a meaningful sell off anytime soon. This view is further supported by the Bank’s willingness to highlight that the base rate is likely to be cut again later this year. However, given what seems to be an obvious desire to avoid negative rates if at all possible, 10 year gilt yields are unlikely to fall significantly from their post announcement historical low level of 0.6%.

The Bank also announced that it intends to buy up to £10 billion of sterling denominated corporate bonds issued by companies that “make a material contribution to economic activity in the UK”. This is likely to result in a significant and sustained compression in the corporate bond yield premium across the entire UK market, given the support that this policy provides to the UK economy, as well as the additional demand it creates for the asset class.

 

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Wednesday, August 10, 2016, 12:00 AM