A Bank of England interest rate hike could be coming sooner than you think

 
Steven Andrew
Consumers Feel The Pinch With Christmas Around The Corner
With preoccupation on worst-case scenarios for Brexit, there is every chance that upside uncertainty is not being priced in to asset values (Source: Getty)

Leaving the EU Single Market could be the most significant structural change to the UK economy in a generation. Then again, the impact might be so small we may not even notice.

Much hinges on the negotiations – and ultimate settlement – on the terms of Brexit, of course. There is also a full spectrum of opinion on what the UK’s future bilateral trade deals with the rest of the world will look like.

Clarity around these issues is unlikely to prevail for some years yet. So, from an investor’s perspective, listening to market noise and rushing to judgement either way is not a good idea.

Focus on wage growth

Instead, investors would do well to take a step back and assess what is really going on. A crucial bellwether will be pay packets.

Wage growth matters because it will point to the direction of UK interest rates – an area where market beliefs could be proved wrong.

The consensus view that the Bank of England will keep base rates at their record low into 2018 is predicated on a slowdown in economic growth. The OECD has projected UK growth of just 1 per cent in 2018 (down from 1.8 per cent in 2016), in stark contrast to its forecast for global expansion of 3.6 per cent, up from 3 per cent last year. Persistently low yields on UK government bonds look consistent with this prognosis.

Read more: Spring Budget: The OBR is still too pessimistic about UK growth this year

This pessimism could be proved right. Perhaps the UK economy will spend the next two years in a uniquely disadvantaged position, reducing its share of growth while most of the rest of the world expands. It might not, however.

Given the economy has defied expectations of a post-referendum slowdown, and that some monetary policy-makers have already begun tip-toeing away from the need for ludicrously low interest rates, it might be worth watching for a meaningful upward shift in beliefs.

A higher pay rise for UK workers could be an early precursor of an interest rate rise.

The case for an upside surprise

Admittedly, annual wage growth in the UK slowed to 2.2 per cent in the three months to January. This is somewhat below where the Monetary Policy Committee would like it to be before lifting rates and making itself unpopular.

Importantly though, unemployment is close to 40-year lows and household earnings accelerated in the six months after June’s referendum. With consumer price inflation already having edged up to 2.3 per cent, and expected to rise further this year, the Bank could easily justify raising base rates once the all-important wage growth box has been ticked.

Read more: A tour of the UK economy in five graphs

This would be a jolt to many investors. Since initial fears of a post-referendum contraction in the economy subsided, most outlooks for the UK have shifted to expectations of slow and steady growth.

With preoccupation on worst-case scenarios for Brexit, there is every chance that upside uncertainty is not being priced in to asset values. Where market beliefs become detached from facts, it creates opportunities for investors who take a long-term view.

The latest figures show we’re not there yet, but wage growth deserves far closer scrutiny – and could ultimately have a far greater influence on investment returns than the latest market noise.

City A.M.'s opinion pages are a place for thought-provoking views and debate. These views are not necessarily shared by City A.M.

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