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 is still trading close to its record high seen last year. However, not all smaller companies carry significant levels of debt, and while these businesses aren’t immune from what’s going on in the wider economy, the drivers of growth can be more secular and idiosyncratic. That can help share prices recover strongly when market sentiment improves. Indeed, the long term performance of this section of the market has 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 might also prompt withdrawals 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 gilt yield rising from 0.3% at the beginning of last year to 1.2% today. 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. So if the Bank of England raises rates, the Exchequer will feel the burn.
Gilt investors – conventional UK government bonds are directly in the firing line if monetary policy tightens, either through interest rate rises or an unwinding of QE. Twelve years of ultra-loose monetary policy has driven gilt prices so high, they now carry an awful lot of valuation risk, and offer a low yield in return. Longer dated bonds can be expected to see the biggest price falls if policy tightens, as they are more sensitive to interest rate rises.
