Economic Update: 3 November 2017
The Investment Management team round-up some of this week’s news.
Bank Of England Raise Interest Rates To 0.5%
Following on from last week’s announcement, let’s look more in depth at the interest rate decision by the Bank of England (BoE) and what effect it has had on both currency and stock markets.
The move was widely anticipated by markets, with a 92% probability that interest rates in the UK were going to hike by ¼%. Furthermore, the Central Bank’s Monetary Policy Committee have sent a hawkish message that at least two further ¼% rate rises would be needed over the next two to three years to control inflation with Mark Carney, the Governor of the BoE, saying “We in fact need those two additional rate increases to get that return to inflation target”.
Inflation in the UK is currently at 3%, around 1% above the BoE’s target, and yesterday’s decision is mainly around controlling that inflation level. The BoE is taking the lead from the Federal Reserve in the US, trying to increase interest rates at a pace not too fast to damage economic growth, but sufficient enough to prevent a sustained rise in inflation.
Looking at the vote itself, economists predicted that the vote would be 6 – 3 in favour of a ¼% rise, rather than the actual result which saw one more vote resulting in 7 – 2 in favour.
Yesterday, the main mover was currency with Sterling falling from around 1.32 just before the announcement to around 1.305 against the US Dollar. The inverse correlation between Sterling and the exporter heavy FTSE 100 continued with the FTSE increasing from around 7,500 just before the announcement and closing at 7,555. Gilts yields also tracked downwards with yields on ten-year gilts falling from 1.35 to 1.24 today.
The reaction of the market may seem puzzling, traditionally when interest rates rise, the domestic currency tends to strengthen. This indicates that the markets do not feel that the second rate rise will be any time soon. In fact, rhetoric from Mark Carney saying rate rises would be “at a gradual pace and to a limited extent” and the removal of a previous view that rates might need to rise more than markets expected indicates that monetary tightening will be slow process.
For the UK as a whole, the economic picture painted was fairly downbeat with growth in the UK now at around 1.5%, with low productivity a significant factor.
Oil Climbs To A Two Year High
On Wednesday, oil (Brent Crude) rose to its highest level for over two years, reaching a price of $61.70 giving hope to oil companies and US shale oil drillers that the industry may have turned a corner after a three-year downturn. Oil price recovery has been under way since June as demand for crude oil has begun to outpace supply, with Brent rallying by over 30% since June.
Much of the recent tightening of the oil market has been driven by OPEC. Responsible for a third of the world’s oil, the cartel, in tandem with other large producers such as Russia, limited oil supply at the beginning of the year, reducing the number of barrels produced each day by 1.8m – about 2% of global supply. In the past week, OPEC and Russian officials have signalled support for extending the supply deal through most of 2018 which should help to keep prices higher. Synchronised global economic growth has pushed demand higher but attention has now focused on how the shale industry will respond and whether increased output from the US producers will effectively cap prices and keep them “lower for longer”.
The prospect of lower oil prices extending indefinitely and the advances made in electric vehicle technology have prompted certain oil producing nations to consider their long term economic strategies.
Brent Crude Oil
Source: Bloomberg, November 2017
Saudi Arabia this week shared their dream of building a new £380bn city for the future, known as Neom. This will be an independent zone, 33 times the size of New York, located next to the Red Sea within Saudi Arabia. It will become a test case for a zero-energy mega city, with its own regulations and social norms, created specifically for the benefit of economic progress and the wellbeing of its citizens, in the hopes of attracting the world’s top talent.
While the ambition for this project may be unprecedented, Saudi Arabia is searching for its place in the future. The city’s vision is to be at the forefront of nine key economic sectors, including energy and water, biotech, advanced manufacturing and food. The project shares the vision which drove the United Arab Emirates to steer oil revenues into healthcare, education and infrastructure but takes the dream a stage further. This is a statement of intent for Saudi Arabia which plans to build a diversified industrial economy fit for the post-oil age by 2030.