But the small print of the announcement contained details that may have a profound effect on clients' investments and property assets.
This was the announcement that the BoE will, after more than a decade, begin the process of reversing quantitative easing, a process known as quantitative tightening.
QE was introduced in the aftermath of the global financial crisis. It involves central banks injecting liquidity into the system through the purchase of bonds. The theoretical reason for doing this is to increase the supply of money in the economy and so stimulate economic growth.
One of the offshoots of this is that bond prices rise, due to the amount of money injected into the system to purchase those assets. Higher bond prices mean lower bond yields, and lower interest rates.
According to economic theory, lower interest rates act as a disincentive to save and so an incentive to spend, which may boost economic activity. Meanwhile, lower bond yields are likely to push people out of safe haven assets and into equities, property and other areas that may also have a more immediately positive impact on the economy.
The impact of QE on equity markets was once described by fund manager Neil Woodford as follows: "If you look at the performance of the economy, then you look at the equity market, the market has gone up by a lot more than the economy, that gap... that's QE."
Bruce Stout, who runs the £1.7bn Murray International investment trust, says the reason asset prices rose at a faster pace than the economy grew is that “you can take a horse to water, but you cannot make it drink”.
By this he means that while one can encourage people to spend more, they will not if they do not feel confident enough to do so, for example as a result of government pursuing spending cuts, as happened from around 2009 onwards, just as the impacts of QE were being felt in the market.
By keeping interest rates low, QE should have helped make houses more affordable, but the effect was to push asset prices higher at a pace faster than wages rose, creating issues in the housing market.
Reverse course
Alongside the interest rate announcement, the BoE confirmed it will not buy any further government bonds until at least 2023, and will also sell about £20bn of the corporate bonds it already owns.
The US Federal Reserve has indicated it will also embark on a process of reversing QE over the coming year.
Deciding not to buy any more of the bonds has the effect of pushing bond yield up. This is because as bonds the central bank already owns mature over the period between now and 2023, the likelihood is the government will issue new bonds in order to return the capital to the central bank on the bonds that are maturing within the next two years.
Previously, as part of the QE programme, the BoE would also have bought the newly issued bonds, but under QT, they will not do this. This means the government will, over the next two years, have to sell more of the bonds it issues on the open market to private investors, this would be likely to have the effect of pushing the interest rate the government has to pay upwards.
The yield on UK government bonds actually rose by 0.07 per cent in the immediate aftermath of the rates announcement.
David Roberts, head of the Liontrust global fixed income team, says: “The BoE, as expected, raised base rates by 0.25 of a percentage point today. There were, though, several surprises, which conspired to move UK government bond yields higher than at any time since mid-2018. First, from March the bank has decided to start selling its stock of gilts, built up after years of QE.”
This is because the BoE bought the bonds without haggling on the price; private buyers are more likely to haggle, particularly with inflation rising.
David Page, head of macro research at Axa Investment Managers, says the decision to allow government bonds to mature without reinvesting the capital will mean £28bn of bonds mature next month, with the central bank not buying the replacement stock.
By buying corporate bonds, that is, bonds issued by companies, the BoE was helping to keep the cost of debt to companies lower as the economy exited recession, by selling some of its existing bonds back into the market. This is likely to reverse somewhat.
James Sullivan, head of partnerships at Tyndall, says: “QT is basically central banks, the biggest buyer of bonds in the market, becoming the biggest seller of bonds in the market, and that has to have an impact.”
Bond yields move inversely to prices, and if bond yields are rising, this has an impact on the rest of the economy.
Market movements
Roberts notes that equities fell in the immediate aftermath of the QT announcement. This is because government bonds are viewed as the lowest risk asset class, so as the income available from there rises, it makes the income from many equities relatively less attractive, potentially impacting equity investors.
In terms of its impact on the housing market, and on mortgages, higher bond yields mean banks can earn profits by simply buying bonds, and so may have less incentive to lend to homeowners or businesses, which are a higher risk way of earning an income, relative to government bonds, where the repayment is essentially guaranteed.
The environment of low interest rates and low inflation created by QE is particularly favoured the technology and consumer staple stocks, often grouped together as “growth shares.”
A reversal of the QE activity may serve to reverse the outperformance of growth shares over the past decade.
Ed Smith, co-chief investment officer at Rathbones, says he believes the market can absorb the QT at present, but is concerned the central bank may be acting too quickly, as the current very high inflation rate in the UK economy may be transitory.
He says: "Long-term inflation expectations have stopped rising, wage growth has fallen back to more normal levels, the latest KPMG REC [jobs] report shows moderating signs of labour supply shortages, the latest manufacturing survey shows falling input prices pressures, the normalisation of consumer spending from goods to services is resuming, and there are signs of supply chain unclogging all around the world.
"The UK will also experience an unprecedented fiscal tightening this year. With this in mind, we think the risks around current interest rate expectations are skewed to fewer rather than more rate hikes than the market is currently pricing for.
"But we will need to wait until the third quarter before we observe the pace at which inflation is likely to fall back, by which point bank rate is already likely to have hit 1 per cent given what has been set out today. The central bank has raised rates [to 0.5 per cent], which is hawkish. It also reduced the corporate bond buying programme from £20bn to £0. This has caught some of market by surprise, although it’s not likely to complete this until 2023.
"So, while it shocked credit markets, when the dust settles, the amount they will sell to the market is about the same as a couple of new issues a month, which the market will absorb.”
David Thorpe is special projects editor at FTAdviser
