InvestmentsNov 1 2017

M&G’s Woolnough backs rate rise as 'recession won’t happen'

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M&G’s Woolnough backs rate rise as 'recession won’t happen'

Mr Woolnough’s word carries much weight in the City as he is viewed by many market participants as having predicted the banking collapse that led to the last financial crisis in 2008.

Speaking at a conference in London today (1 November), Mr Woolnough said the Bank of England should not have cut interest rates in the immediate aftermath of Britain's vote to leave the European Union, when it took them from 0.5 per cent to 0.25 per cent last August.

The Bank should continue to move in line with the US, he said, where rates have been rising.

It is widely expected by the market that the Bank of England’s Monetary Policy Committee with announce an interest rate increase on 2 November.

Monetary policy should not be set with Brexit in mind as it is still "years away" from happening, the fund manager said.

He added a falling currency, as the UK has seen with the hit to the value of sterling in the year since the Brexit vote, has the same impact on an economy, pushing borrowing costs down, as an interest rate cut, making the cut unnecessary.

Bryn Jones, who runs the £950m Rathbone Ethical Bond fund, has said the Bank of England “messed up” by cutting rates, as the impact of the falling currency and lower rates would be much higher inflation.  

UK inflation is currently running high at 3 per cent, above the Bank of England's 2 per cent target.

UK economic growth was 0.3 per cent in the the third quarter of this year.

By comparison, in the US third quarter GDP growth was 3 per cent.

Mr Jones said UK and US monetary policy was moving in step, and so were inflation rates, until Brexit, which delivered a shock to the UK economy.

The day after the Brexit vote the Bank of England cut interest rates, while the US Federal Reserve continued its path of putting them up, causing inflation to fall in the US, and growth to rise, while the opposite happened in the UK.

The US has been putting rates up for a year with, as yet, no sign of the pace of economic growth slowing down.

Mr Woolnough said neither of the two trends that lead to recession are evident in the world.

The first is a steep rise in the oil price.

This caused recessions in previous decades because it reduces the amount of spare cash consumers have to spend in other areas of the economy.

Secondly, Mr Woolnough takes the view that increased regulation of banks means there is not enough lending happening in the UK or globally to create a credit bubble, and without a credit bubble, “there is no bubble to burst, and it is the bursting of bubbles that leads to recessions”.

He expects low growth with inflation and interest rates peaking at lower than historic levels to be defining characteristics of the UK economy in the years ahead.

However his comments come in the wake of consumer group Which warning that just a 0.25 per cent increase in interest rates will negatively impact the finances of millions of mortgage owners.

The Financial Conduct Authority has also warned that many homeowners lack the capacity to withstand even a modest increase in rates.

David Coombs, multi-asset manager at Rathbones, is much more wary on the outlook for the UK economy if rates rise.

He said: ““A sustained increase in interest rates from now could be damaging to an already fragile economy.

"UK GDP growth has been steadily revised down and currently sits at 1.5 per cent, the lowest level since 2013. Real wage growth is negative, the housing market has softened and business investment has been listless – there seems to be little left to inject some life into the economy.

"Japan increased interest rates in the late 1980s to pop an inflationary bubble in asset prices. The result was deflation, recession and more than 20 years of poor economic growth.

"We think the Bank is behind the curve: it should have raised rates years ago when economic growth was stronger. Doing it now could be devastating to income-producing assets in the UK. It seems like Mr Carney’s rhetoric is aimed at bolstering the pound.

"But if he fails we could have even greater inflation and a recession at the same time. We remain very underweight the UK.”

Mr Woolnough said despite global economic data being positive, low yields in the bond markets mean investors are pricing recession. 

That disparity has prompted him to buy bonds with a short date to maturity and more sensitivity to the global economy. This is precisely the opposite to the actions he took in late 2007, when he feared a global recession.    

David.Thorpe@ft.com