Reaction to Bank of England's big interest rate hike

Investors expected the 0.5% rate rise and now shift their attention to the chancellor's emergency mini-budget tomorrow.

Investors in rate sensitive sectors such as banking, housebuilding and retail have been told the Bank of England will “respond forcefully” if looser fiscal policy stokes the inflation fire.

The Bank’s base rate is now 2.25% after today’s second consecutive rise of 0.5%, but the latest tightening barely caused a ripple for most UK-focused shares as attention is already on the details of chancellor Kwasi Kwarteng’s Growth Plan due tomorrow.

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Today’s increase was smaller than some had forecast in the City beforehand and contrasted sharply with the US Federal Reserve’s third 0.75% increase in a row last night.

However, the biggest rise in UK rates in three decades is still on the cards if economic projections available at November’s meeting show the government’s fiscal plans boosting demand and inflation.

Today’s Bank minutes said: “Should the outlook suggest more persistent inflationary pressures, including from stronger demand, the committee will respond forcefully, as necessary.”

Capital Economics said this was a “not-so-subtle reference” to the loosening in fiscal policy that’s expected to be announced tomorrow: “In short, the Bank has indicated it will raise rates further to offset some of the boost to demand from the government’s fiscal plans.”

Tomorrow’s statement is expected to include a cut in stamp duty in order to bolster the property market, as well as widely-trailed plans to reverse a previous national insurance rise and to freeze corporation tax.

An energy price guarantee has already been announced for households, which the Bank believes should lower the peak for inflation to 11% in October and reduce the risk of more persistent wage pressures.

However, it also means that household spending is likely to be more robust and result in price pressures staying around for longer.

Capital Economics thinks loose fiscal policy will contribute to the labour market remaining tight well into next year and inflation expectations proving sticky.

This means the consultancy expects the Bank to raise rates by 0.5% at each of the next three meetings, although it hasn’t ruled out a 0.75% increase in November. It sees a level of 4% by March, with the Bank unable to contemplate rate cuts until 2024.

That prospect should provide further support for the margins of banking stocks, with Lloyds Banking Group shares now up 9% in the past month.

Bank of America has “buy” ratings on Lloyds, NatWest and HSBC and said comments from CEOs at an industry conference this week had reinforced its optimism for an upside to consensus revenue expectations should the anticipated rate hikes materialise.

It adds that the structurally lower exposure to credit in the banking system should enable the banks to deliver higher returns than the “modest levels” currently forecast.

NatWest shares, however, have retreated in the past two days after Bloomberg reported that the UK government is looking at changes to the Bank of England’s money printing programme.

This would see the scrapping of interest paid on some deposits held by commercial lenders at the Bank, potentially saving more than £10 billion a year. NatWest shares closed 2% lower last night and lost another 3.9p at 260.2p today.

For housebuilding stocks, the 0.5% increase in the Bank’s base rate had little immediate impact as higher mortgage rates have already been factored in by lenders.

The sector has already lost about 40% of its value this year due to the risk of a house price downturn if mortgage rates top 5% in the next year. But UBS said today it remains supportive of the sector, pointing out that a stamp duty cut could improve the demand outlook in the same way as during the pandemic in 2020/21.

“Despite a potential stamp duty cut, we still think that affordability is the main concern moving forward,” it added.

The bank’s top pick is Berkeley Group, which it says has lower relative risk due to its long order book and land bank. The shares drifted 8p lower at 3547p today, but UBS said the current level compared with its “liquidation” value of 4,700p a share.