‘Bond proxies’ – would also likely see share prices come under pressure, as investors are tempted out of companies like Unilever, Johnson & Johnson and the utilities sector, and back into their natural habitat of bonds, as yields rise and therefore offer better relative returns. The share prices of these companies have done exceptionally well in a low interest rate environment, but they will find the going gets tougher if monetary policy tightens.
Banking sector – higher interest rates would be good for banks. The ultra-low interest rate environment has compressed the interest margin between deposits and loans, which are a bedrock of profits for commercial banks. Bad loans shouldn’t tick up too much, as any interest rate rises are going to be very gradual. The slow pace of tightening policy means bank profits aren’t going to skyrocket overnight, but shares may well appreciate as the market prices in a better monetary backdrop for the sector.
Smaller companies – in theory, smaller companies are more fragile than their blue chip cousins, as they have less robust earnings streams and access to capital. In some cases, higher interest rates would increase their debt burden, and could push them further towards the cliff edge of losses and insolvency. Their stock prices are often predicated on longer term growth too, and so higher interest rates and inflation could mean we see some valuations pegged back. That’s particularly the case seeing as the UK’s small cap index has been hitting record highs of late. However, not all smaller companies carry significant levels of debt. And while smaller companies aren’t immune from what’s going on in the wider economy, the drivers of growth are more secular and idiosyncratic, which can bolster share prices even in troubled times. The long term performance of this section of the market has also been exceptionally strong, particularly when partnered with active fund management.
Residential property – higher mortgage rates should take some of the steam out of the housing market. Prices could fall, but a moderation of price growth seems more likely, given the ongoing imbalance between supply and demand, and the presence of continued government support in the form of Help to Buy and the Mortgage Guarantee scheme. The Bank of England certainly won’t want to put so much strain on the economy that homeowners are posting their keys through the letterbox as they leave, because they can’t afford mortgage payments.
Commercial property – commercial property prices could also come under pressure from interest rate rises, which heap pressure on tenants by increasing their debt bills. If the economy is in fine fettle though, that should mean businesses can afford the extra costs, though the good times may not be split fairly amongst all sectors. As an asset normally held for income, the commercial property sector may see outflows if bonds and cash start offering a more attractive yield. That could spell more trouble for the open-ended funds invested in commercial property, where large outflows might increase the risk of trading suspensions. The sector is already on tenterhooks waiting for the FCA to announce if notice periods will become mandatory, which could also prompt an exodus from the sector.
Taxpayers – rising interest rates would also be extremely negative for government finances, and by extension, the taxpayer. Government bond prices have already adjusted to the prospect for higher inflation and tighter policy, with the 10 year yield rising from 0.5% to 1% since the beginning of August. In ‘normal’ conditions, rising rates only affect new government borrowing, but today, the QE programme has effectively pegged £875 billion of government debt to the base rate. This is a floating rate that can change interest payments overnight, unlike the fixed rates of the gilt market.
