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Banks jump on interest rate hike

Rising lender income looks like one safe bet from the BoE's market-moving decision
Banks jump on interest rate hike
  • Bellwether stock Lloyds up 5 per cent
  • Outlook for UK equities finely poised

Shares in the UK’s banking sector jumped on Thursday afternoon after the Bank of England surprised markets by lifting interest rates from 0.1 to 0.25 per cent at its December meeting.

Lloyds Banking Group (LLOY), the country’s largest domestic lender and often seen as a bellwether stock for the UK economy, climbed 5 per cent after the Monetary Policy Committee (MPC) decision. Shares in HSBC (HSBA), NatWest (NWG) and Barclays (BARC) all posted gains of at least 3.5 per cent, while the loss-making Metro Bank (MTRO) climbed 8 per cent as investors bet the group would stand to gain more from tightening monetary policy.

Though the move increases lenders’ cost of deposits, banks’ ability to pass on higher interest charges to borrowers and customers means they tend to benefit from rising rates. This means net interest margins – the difference between interest earned and interest paid out, divided by a bank’s average assets – should climb.

This adjustment will be gradual, however. For Lloyds and NatWest, which earn a greater portion of their net income from the mortgage market, a relatively small interest rate rise should be seen against a highly competitive mortgage product market, and the fact that more than 90 per cent of new mortgages and four-fifths of existing mortgages are on fixed term deals.

How fast rates will rise in 2022 remains a key question for markets – and poses a big decision for the Bank of England governor Andrew Bailey and his colleagues.

Today’s hike, which was signed off by the MPC with an 8-1 majority, had been expected last month amid persistent signs of rising inflation. Traders had broadly interpreted November’s rate freeze as a stay-of-execution until the new year, but the committee said further labour market tightening and “greater persistence in domestic cost and price pressures” over the past month meant a 0.15 percentage point rise was warranted.

The central bank added that while the Omicron coronavirus variant was likely to weigh on near-term economic activity, its medium-term impact on inflationary pressures is “unclear at this stage”. MPC members now expect inflation to hover at around 5 per cent this winter, and “peak at around 6 per cent in April 2022”.

Leading UK share indices opened the day’s trading around 1 per cent higher and held on to their gains when the BoE’s decision was announced at midday.

Other beneficiaries of higher rates include the investment platforms Hargreaves Lansdown (HL.) and AJ Bell (AJB), both of which have built up sizeable high-margin cash savings businesses in recent years. Hargreaves shares jumped more than 6 per cent following the announcement, which investors are likely to have interpreted as bullish for household investing and savings rates.

House broker Numis upgraded the stock from ‘add’ to ‘buy’ on the development, as analyst James Hamilton predicted a 25-basis point rise in interest rates would boost profits by 10 per cent.

The broader outlook for UK equities, and markets’ potential response to tightening monetary policy, is finely poised. Futures markets now expect bank rate to climb above 1 per cent by the end of 2022, and to dip thereafter – meaning Threadneedle Street must navigate an awkward set of market expectations at a time when inflation is at a decade high and the pandemic continues to rage.

“The markets are telling us that the BoE is at risk of making a policy mistake as the yield curve is inverted suggesting any policy tightening now in response to inflationary pressures may have to be reversed pretty quickly,” said Georgina Taylor, multi asset fund manager at Invesco. “This could lead to a volatile period for UK assets.”