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The rate threat

A rise in Bank rate next month might do more damage than usual
The rate threat

'This time is different' are words usually associated with dangerous complacency. In one sense, however, this time really might be different in a way that’s bad for equities – because it’s possible that the macroeconomic and stock market reaction to rising interest rates might be worse than usual.

Since the Bank of England warned last month of “an ongoing tightening of monetary policy” in coming months, traders have expected a rise in Bank rate next month, with another following later in the year.

History suggests this doesn’t much matter. Bank economists have estimated that a half-point rise in Bank rate cuts output by only 0.3 per cent, which is only a fraction of the forecast error in GDP. Partly because of this, rate changes have historically had little effect on share prices. Between 1985 and 2008 (just before Bank rate fell to 0.5 per cent) the correlation between Bank rate and the All-Share index was minus 0.11 for monthly changes and 0.04 for annual changes. Both are statistically insignificant from zero. In other words, shares have been about as likely as not to do well as badly when rates rise. Sometimes shares have done well as interest rates have risen, such as in 1988-89. And other times they’ve done badly, such as in the mid-1990s.

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