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We’ve often said that forecasting’s a mug’s game, and the Bank of England yesterday proved us right by making mugs out of everyone (including, we have to say, ourselves) who predicted there’d be no rise in interest rates this month.
Only one man in the City (Simon Ward of New Star Asset Management) correctly guessed that the Bank would hike rates to 5.25% – well done to him.
That’s not to say that we think the decision is wrong. On the contrary, we wrote before December’s rate-setting meeting that a shock rise was exactly the medicine the economy needed.
So we think the Bank’s move to shock the City this month was absolutely right – even though we’d like to have seen it come before everyone had blown all their cash on Christmas presents.
While the City and estate agents rend their hair and yelp, the Bank is presumably hoping that this stitch now will save nine later down the line – but is it enough?
We’ve said it repeatedly in recent months – markets across the globe are overly complacent about the risks facing the economy. And the Bank of England’s Monetary Policy Committee (MPC), lead by Mervyn King, clearly agrees.
The City, estate agents, industry, unions – almost all were united in their condemnation of the rate hike. But the reality is that it was about time that the Bank shook things up a little.
Inflation by any measure – even the consumer price index (CPI) figure that has taken so much flack recently – is at multi-year highs. At 2.7%, CPI is just below the 3% target that would mean the Bank having to write an open letter to the Chancellor explaining why.
Next week, inflation figures for December are revealed to the public, but the Bank would have seen them during its meeting – and judging by its reponse, they can’t be pretty. The British Retail Consortium has already reported that shop price inflation was up 2.3% year-on-year last month, despite all the pre-Christmas press reports of widespread discounting.
Given that shop price deflation has been one of the few things keeping CPI in check, it may well be that CPI for December has already breached the 3% target. As The Times points out: ‘Any letter will be easier to write if the MPC has already responded to such an inflationary overshoot.’
The Bank is also clearly worried that people are losing faith in how well inflation is being controlled. Consumers’ expectations for future inflation are rising, and the recent criticism in even the mainstream press of inflation measures shows just how little people feel that the official figures reflect their personal circumstances.
When inflationary expectations become entrenched among employees, that’s when they demand higher wages. And with January the key pay round month, the Bank probably felt that sticking to the City’s expected timetable of a February hike would be too little, too late.
And then of course, there’s house prices. Lenders are still merrily engaged in a race to the bottom, to relax lending standards on both buy-to-let mortgages and sub-prime loans. This is storing up serious trouble, just as overly generous credit card lending leading up to 2003/04 has caused the current bad debt problems being suffered by most British banking groups.
The Bank’s latest rate hike may not stop the housing hysteria in its tracks – but it may well make some people think twice before committing to that lovely two-bed flat with the negative rental yield that they saw as a ‘long-term investment’.
But the big question is – will the Bank stop now? As regular readers may have guessed, we have our doubts. This surprise hike will certainly take some pressure off the Bank – by confounding City expectations, it’s showing that it has a hard line on inflation, and it may wipe some of the exuberance out of the market.
But there’s plenty of signs of complacency still there. The FTSE 100 all but shrugged the hike off – it suffered a 30-point fall just after the announcement, but then ended the day around 70 points higher. It wasn’t so long ago that even a hint of an interest rate hike was sending traders scurrying for the hills.
So clearly, like everything else, the markets are putting a positive spin on what would normally have been a nasty surprise. The twisted bull logic probably goes something like this – ‘if the Bank hikes now, that means it won’t have to hike later. So in fact, interest rates are going to peak even earlier! That’s great news!’
As long as the markets are thinking this way, the Bank’s job isn’t done. The fact is that interest rates have been too low for too long, and bringing the economy back into balance will unfortunately require a lot more discomfort than the slap delivered by Mervyn King and chums yesterday. But it’s a start.
On another note, the rate hike will certainly have an impact on everyone’s personal finances. So it’s not a bad time to start taking some advice on how to make sure your financial household is in order.
MoneyWeek editor Merryn Somerset Webb is launching her own weekly personal finance email – Money Matters – where she’ll be giving her own no-nonsense take on everything from getting rid of debt to the best ways to invest for the future. Make sure you’re on the list to receive her first email – just click here to sign up: Money Matters
Turning to the stock markets…
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In London, strength in the mining sector offset the Bank of England’s surprise decision to raise interest rates yesterday. The FTSE 100 index of leading shares closed 69 points higher, at 6,230. Stronger metals prices saw miners BHP Billiton, Kazakhmys and Xstrata top the FTSE leader-board, whilst Alliance Boots chalked up the biggest losses on of the day following less-than-spectacular results. For a full market report, see: London market close
Elsewhere in Europe, the Paris CAC-40 jumped 107 points higher to end the day at 5,609 after the ECB indicated that it would keep rates on hold for the time being. In Frankfurt, the DAX-30 also ended the day sharply higher, gaining 120 points to close at 6,687.
Across the Atlantic, the Dow Jones soared to a new record close of 12,514, a 72-point gain, with tech stocks such as Microsoft and Intel giving the index its biggest boost. Strength in the technology sector also propelled the Nasdaq to close 25 points higher at 2,484, just off a six-year high of 2,489. The S&P 500, meanwhile, gained 9 points to close at 1,423.
In Asia, the weaker yen together with strength on Wall Street helped the Nikkei to a a close of 17,057, a 218-point gain.
Crude oil was last trading at $52.80 a barrel, its price having risen nearly 2% today. Brent spot was also higher at $51.72.
Spot gold last traded at $612.30 this morning.
And in London today, record company EMI issued a profit warning following poor Christmas sales of new releases such as Robbie Williams’s album ‘Rudebox’. Full-year pre-tax profit forecasts have been cut from £160m to £112.8m. The group also announced the departure of the chairman and vice-chairman of its music division. Shares in EMI had fallen by nearly 10% this morning.
And our two recommended articles for today…
The best asset classes to invest in now
– Whether they invest in stocks, bonds or commodities, it seems that investors in every asset class are convinced about the soundness of their judgement. But history reminds us that some will be very wrong, says Puru Saxena. For more on whether commodities are in a bubble and which assets will benefit from US interest rate rises, read:
The best asset classes to invest in now
Six essential investments for 2007
– There are six key areas and themes which all investors should have exposure to, according to the Daily Telegraph’s Tom Stevenson. To find out if you’re lacking any right now, see:
Six essential investments for 2007