The Bank of England has raised interest rates for the first time in three years. But what could this mean for UK shares and should I make any changes to my Stocks and Shares ISA? Those are the questions that I’m asking myself today.
The central bank decided to increase its base rate of interest to 0.25% from the record low rate of 0.1%. It did so despite the Omicron variant threatening to disrupt the economic recovery. The main reason it chose to act now appears to be an attempt to keep inflation under control. From used cars to gas bills, prices have been rising across the board. Analysts expect inflation to hit 6% next year. That’s triple the bank’s target. That said, despite this rate hike, interest rates are still near record lows and are unlikely to threaten any economic recovery, in my opinion.
Will a rate hike affect UK shares?
Some UK shares are more affected by interest rates than others. For instance, it could be good news for high street domestic banks including Lloyds, Barclays and Natwest. In fact, all three banks were among the top performing FTSE 100 shares on Thursday, the day of the hike. Generally, banks can benefit from higher interest rates. They profit from the difference between interest earned and interest paid out. When rates rise, they can potentially pass on these higher charges to customers.
So will bank shares continue to benefit? Well, it’s not that simple unfortunately. There are several other factors at play. Banks also benefit from a thriving economy. Currently, there are parts of the economy that are struggling. Just when the hospitality and travel sectors were starting to recover, the latest variant caused a setback. This part of the economy has been hurt from cancelled pre-Christmas parties and frequently changing travel restrictions. Many bank shares have struggled to reach pre-pandemic levels, and I reckon any gains could still be limited for now. I don’t currently own any bank shares in my portfolio. I will monitor them but for now, I’m finding much more compelling share ideas elsewhere.
Shares to avoid?
If rate rises continue next year, which UK shares should I avoid? If inflation continues to rise, the Bank of England could increase interest rates further. In that scenario, I’d be keen to avoid companies in the utilities sector. Shares including National Grid, United Utilities and SSE could all underperform. Utilities shares tend to compete with bonds. So when interest rates rise, multi-asset investors can shift funds from utilities to higher-yielding bonds.
Some things to bear in mind, however. There could still be a small place for utilities in my portfolio. They tend to offer defensive characteristics and higher than average dividend yields. As such, they can act as a balance to some of the more volatile growth stocks in my portfolio.
Overall, although the interest rate rise could affect several UK shares, I’m currently happy with my portfolio and won’t be making any significant changes.
