Futures markets reckon the next two moves in the Bank of England's base rate will be upwards (see ). History suggests this wouldn't be too bad for shares. In the last 20 years, there have been six phases of sustained rise in the base rates. The All-share gave a positive return in five of these, with an average monthly rise in all six periods of 0.7 per cent - only a tad shy of the 0.8 per cent average for all months since 1988. Overall, then, rate rises haven't been bad for equities.
Rate rise history
| Period | From | To | All-Share return |
|---|---|---|---|
| May 88-Oct 89 | 7.5 | 15 | 24.9 |
| Aug 94-Feb 95 | 5.25 | 6.75 | -6.9 |
| Sep 96 - June 98 | 5.75 | 7.5 | 48.6 |
| Aug 99 - Feb 00 | 5 | 6 | 2.6 |
| Oct 03 - Aug 04 | 3.5 | 4.75 | 7.3 |
| July 06 - July 07 | 4.5 | 5.75 | 12.9 |
What's different now?
In the past, rising rates haven't troubled shares much because they have come at a time when the global economy has been doing well. And that's caused profit expectations and risk appetite to rise, offsetting the rising cost of money.
However, a rate rise this year - if it happens - would almost certainly not be accompanied by such an upswing. Sure, it's quite possible that the US economy will pick up. But many investors will remain very wary of this. Instead, rising interest rates could, unusually, add to uncertainty about the economic outlook, which would depress risk appetite.
And even if this doesn't happen, theory tells us that rising interest rates - other things being equal - must be bad for shares. The reason for this is simple. Equities are riskier than cash, so they must always offer higher expected returns. Rising interest rates must therefore mean rising expected returns on shares. But expected returns can only rise if prices fall, to a level from which they are subsequently expected to recover.
Of course, theory tells us that this should have happened by now. The stock market should have heeded the message of short sterling futures and be already discounting higher rates - which should be why the All-share has dropped recently.
But I'm not confident about this. The market seems to have only recently cottoned onto the fact that the housing market has gone pear-shaped. So perhaps it's not so quick to discount things after all.
