Comments made last week by Bank of England Governor Mark Carney regarding monetary policy caused shares to spike. That’s unsurprising as a more dovish stance from the Bank of England (which could mean a lower interest rate) would be likely to have a positive impact on valuations across the FTSE 350 and among smaller companies too.
First the good news
That’s because a loose monetary policy could help to stimulate the UK economy, partly through a lower interest rate causing sterling to weaken. Although sterling has already fallen in the wake of the EU referendum vote, it could fall further and this would have a positive impact on the UK economy through making British exports (and exporters) more competitive.
In tandem with earnings growth boosting UK GDP, lower interest rates should also encourage people to spend. That’s because the cost of borrowing will fall, so mortgage rates may be lower and leave homeowners with a larger amount of disposable income. Similarly, credit card debt and other loans could become more attractive to hold, thereby encouraging individuals to buy more and save less.
Now for the bad news
On the topic of savers, a looser monetary policy is clearly bad news for them. High street banking rates are already extremely poor and it may be the case that obtaining 1% on an instant access savings account soon becomes impossible. While at the moment that wouldn’t cause the value of cash to fall in real terms (i.e. when inflation is taken into account), the reality is that inflation could rise. A weaker currency will make imports more expensive and it seems plausible that inflation will now move higher.
Clearly, higher inflation is bad news for bonds. They offer a flat return and so increased inflation would hurt their real-terms returns. But with interest rates moving inversely to bond prices, those bond prices could increase and at a time when uncertainty regarding not just UK growth but global economic growth is high, bonds could gain favour among fearful investors over the short-to-medium term.
Even house prices could gain a boost from falling interest rates, since lower borrowing costs could encourage more people to buy property. And weaker sterling may also lead to an increased number of foreign buyers who are able to get more square footage for their money.
However, the reality is that the UK housing market is closely linked to the outlook for jobs and due to the high level of uncertainty that’s present in this regard, many UK-based buyers may wait and see how Brexit plays out before taking the plunge. Similarly, foreign buyers may be put off by the known unknown of life in a post-Brexit world.
Shares: risks and rewards
One place that could offer strong growth in spite of Brexit and a loose monetary policy is the stock market. Firms that operate globally have already won investor favour post-Brexit and this trend could continue over the medium term. Similarly, UK-focused stocks could benefit if lower interest rates help stimulate demand for goods and services despite lower confidence in the UK economy.
Price falls of a number of UK-focused stocks mean they now offer wider margins of safety. For long-term investors there could be bargains out there. Although volatility could continue over the coming months, the rewards from risk-taking now through buying shares may be high and allow Foolish investors to continue to derive excellent returns.
