Toby Nangle, Head of Multi-Asset, EMEA, at Columbia Threadneedle Investments comments on the UK interest rate rise today and immediate market reaction: “The Bank today reversed the interest rate cut that they made last August, increasing rates for the first time in ten years to 0.5%. The impact of this hike on households looks to be minor in the context of a variety of fiscal changes that are in train.
The market had almost fully discounted the increase in interest rates that the Bank of England voted 7-2 to make. This would typically mean that there would be little reaction. However, the immediate market reaction has been for the pound to fall by over 1% against all major currencies and for UK bond yields to fall sharply. UK stocks rallied but this looks to reflect almost entirely the currency move: they underperformed overseas equities in common currency terms. The reason for this reaction was that the Bank dropped the line from its statement that rates may need to rise more than the market expects, and this was interpreted by the market as removing some risk that this was the first of many rises to come.
The Bank furthermore judged that despite lacklustre economic growth, the UK has been growing above its speed limit, sending a grim message to the market around its expectation for potential UK economic growth.”
In response to the Bank of England’s decision to increase interest rates by 0.5%, Matthew Brittain, Investment Analyst at Sanlam said: “The UK has not seen an increase in its base rate for over 10 years, so while today’s announcement doesn’t come as a surprise, it marks a significant moment. The graph below reminds us how quickly the rate of interest fell in the wake of the 2008 financial crisis, and for how long it has remained close to zero.
“The Monetary Policy Committee (MPC) has a clear mandate to keep inflation at 2%. This maintains price stability, and gives people confidence that the currency will maintain most of its purchasing power. With the Consumer Prices Index (CPI) rising to 3% in September, its highest level since April 2012, the MPC has taken preventative action to head off the possibility of further inflation increases, and the need for aggressive rate hikes in the future.
“We don’t think this is the start of a series of rate increases. Indeed, we believe inflation will return to target levels of its own volition, as the effects of a weak Sterling dissipate. The UK remains in a precarious economic position with high levels of consumer debt and the Brexit negotiations delaying investment decisions, so we think that low interest rates are helpful in keeping the economy strong. Assuming the inflation outlook stabilises, we think this is the first, and last, interest rate hike we will see for a while.”
“Matching Adjustment remains critical for annuity insurers, despite today’s rate rise” says Chris Price, Insurance Solutions Strategist at AXA Investment Managers.
“With the Bank of England announcing the first base rate rise in a decade annuity insurers might be tempted to breathe a sigh of relief. However, there is little expectation that this will be the start of a return to normal levels for rates. Future increases are likely to be small and slow in coming and therefore the Matching Adjustment (MA) remains critical for annuity insurers.
“Insurance annuity writers are mainly a feature of the UK and Spanish markets but with the insurance buy-outs of pension schemes now more common in other jurisdictions Matching Adjustment becoming an important aspect of Solvency II Regulation.
“The ability to discount liabilities at the rate earned on a Matching Adjustment portfolio, rather than an adjusted risk-free rate is a critical competitive advantage and the higher the return available from such a portfolio the better. The MA regulations essentially require that the cash flows from the assets must match the cash flows from the liabilities closely, with only a small probability of mismatch over time. Vanilla investment grade credit yields little, but many higher yielding assets do not meet the rules.
“Insurers must look for new and innovative ideas for high yielding assets which, while they do not necessarily meet the rules in original form, can be restructured to do so. UK insurers are, for example, looking beyond the sterling markets for example and finding ideas such as a portfolio of Dutch Mortgages, Equity Release Mortgages and Student Loans are an attractive fit. An asset manager capable of carrying out the restructuring is also essential to ensure regulatory compliance.”
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