According to Hargreaves Lansdown’s Investor Confidence Survey, 90% of investors expect UK interest rates to rise within the next 12 months. The unexpected jump in inflation from 1.5% to 1.9% has also fuelled speculation that rates will rise sooner rather than later.
“Investors are gearing up for an interest rate rise within the next year, and a substantial proportion even expect some movement by the end of 2014,” said Laith Khalaf, Senior Analyst at Hargreaves Lansdown.
“The surprise jump in CPI last month is unlikely to prompt a knee-jerk reaction from the Bank of England, it is after all just one data point and still within the Bank's 2% target. Wage inflation is an important measure they will be monitoring. Provided it remains muted they are likely to view this as an anchor on CPI.”
He added: “When rate rises do arrive the Bank of England wants a gradual ascent, and will have the scope to achieve this as long as inflation remains contained, which would make any relief for cash savers muted in the short term.”
The 90% figure compares to 35% last June, and 65% as recently as April 2014, which shows a big step change in interest rate expectations over the last two months. So much so, 36% of investors now expect a rise by the end of 2014.
CPI rose from 1.5% in May to 1.9% in June, going against expectations of a small rise to 1.6%. The rise in June was mostly down to increases in clothing prices, with suggestions that this may have been led by retailers delaying their summer sales this year.
A word of caution has been sounded, though. Whilst the market is all set for an interest rate rise in the next year, this wouldn’t be the first time investors’ expectations have been thrown a curve ball. The last time interest rate expectations were this high, according to the Hargreaves Lansdown Investor Survey, was in May 2011, shortly before the European sovereign debt crisis kicked interest rate rises into touch. In the subsequent year, the 10 year gilt yield fell from 3.3% from 1.5%.
This showcases the dangers of making big calls on interest rates. Particularly for bond investors who might quite rationally have exited the bond market at several points in the last couple of years, only to watch it rise further.
As such, the current interest rate environment represents a conundrum for bond investors. “They like the income paid by bonds, but are wary that rising interest rates will prompt bond prices to fall,” Khalaf said. “We think at the present time bond investors should consider Strategic Bond funds which have the flexibility to invest across the fixed interest spectrum, with the potential to offer greater protection from interest rate rises. This does depend heavily on the skill of the manager however.”