John Royden, Head of Research
Three months ago we said that “the next base rate rise will be up, not down” and not much has changed on that front. But the question of when still abounds.
The answer to that probably lies on the other side of the Atlantic with attention focussed on the progress, or lack of progress, of Trump’s election promises. If Trump kicks his reflation pledges through Congress’ political constraints that will help the US economy with a benign effect owing through to the rest of their trading partners, including the UK. And if that happens, it should put upward pressure on inflation and UK rates.
The initial failure of the repeal of Obamacare brought into question Trump’s ability to run his election manifesto through Congress. It also constrained his fiscal ability to finance the rest of his initiatives. Trump had thought that money saved on Obamacare would finance his tax cuts, the Mexican wall and a degree of infrastructure investment in America’s pothole-ridden roads.
From my personal perspective, I also noted that his wavering on pulling out of NAFTA, the North American Free Trade Agreement, and the rather unexpected pro-growth and pro-trade results of the Mar-a-Lago meeting with China’s Xi Jinping bode much better for growth than the initial post-election expectations. Added to which border taxes now look to being side-lined in light of the progress of Trump’s second crack at Obamacare.
We now read that Trump’s second attempt to replace Obamacare got just enough votes (217 to 213) in the House of Representatives to progress through to the Senate. But with a Republican majority of only 2 (52 of 100) the result is by no means a given. At least one Republican, Rob Portman, says that he won’t support it.
Back in the UK we have momentum in inflation on the back of the pound’s post-Brexit weakness, wage inflation from the minimum living wage and the impact of increases in business rates. The not- unattractive outcome of the French elections should foster the first green shoots of European economic growth and generally, global growth looks well supported with leading indicators advancing, more business spending and jumps in factory orders and capex intentions. Consumer confidence is on the up as well which all points to economic strength, more inflation and upward pressure on rates.
The negatives for the UK, which will weigh on the Bank of England’s thinking, remain the worries that surround the prospect of an uncomfortable Brexit balanced against the need for some kind of reaction to the possibility of inflation running away with itself. With unemployment nudging the 4.5% level, but showing signs of falling at a lesser rate, the Bank of England will keep its beady eyes on wage inflation and whether it starts to climb into an iterative and self- reinforcing increase in inflation.
So with the prevailing wind blowing in the direction of interest rates tending towards up rather than down, and in spite of the squallish political weather across the Channel, we hold the line and stay short duration in fixed income. That loosely means up to three years maturity in investment grade corporate bonds and up to six or seven years in gilts. From a tactical perspective, there may be some short term economic weakness in the early summer, so some investors might be waiting for a small sell off.