Inflation at 5.4% shortens odds on another rate rise in February: But what does it mean for savers and investors?

The headline rate of consumer prices index inflation has risen to 5.4% in December from 5.1% in November – that’s above consensus expectations of 5.2% and the highest rate in 30 years.

Adrian Lowery, personal finance expert at investing platform Bestinvest says that with the Bank of England seeming more hawkish on inflation, another rate rise on 3 February at the next Monetary Policy Committee is on the cards.

‘Even before today’s inflation data, money markets were fully pricing in one rate hike by next month and one full percentage point increase in interest rates by the end of 2022 - in other words a bank rate of 1.25% by year-end,’ Lowery adds.

‘That’s not to say of course the MPC will move again in February: there will be no certainty over the full economic impact of Omicron in December and January, and this could well give the rate-setters pause for thought,’ Lowery adds. ‘But it will be a split decision.’

WHAT DOES THIS MEAN FOR SAVERS?

Savers with cash sat in deposit accounts should take little comfort from the fact that the Bank of England will probably hike its benchmark rate a couple more times this year. What’s happened since the MPC slightly unexpected hike from 0.10% to 0.25% on 16 December?

Not much on the part of the big banks.

Barclays last week became the first High Street name to react to the 0.15 percentage point rise in base rate by raising the interest on its Instant Cash Isa from 0.02-0.05% to 0.05-0.10%. Its rivals are paying rates like 0.01% on easy-access accounts.

Adrian Lowery says that most of the big banks are disinterested in attracting savers’ deposits: ‘It’s unlikely this will change any time soon – even if the MPC hikes rates further this year.’

‘Although a bank rate of 1.25% would notionally be the highest for 13 years, it means virtually nothing to savers: the UK’s leading retail banks don’t need savers’ deposits and so will probably decline to pass on base rate hikes in any meaningful way,’ he adds.

‘And even if they did, interest is more than eclipsed by inflation, leaving real returns on cash savings deeply in the red. When will real interest rates on savings reach zero, and inflation cease to eat into the value of cash deposits?

‘When savings rates are at 2% and inflation at 2%? That is not an equation that is going to happen for a long time.’

WHAT ABOUT BANK SHARES?

What has happened to the big retail banks’ share prices since 16 December. As of yesterday, Barclays and Lloyds were both up by 20%, Metro Bank 17.5% and Natwest (RBS) 15.3%. In comparison, the wider UK stock market has risen by 3.3% over the same period.

Rising interest rates are generally good news for retail banks as it means they can grow the margin between what they earn from loans and what they pay on deposits.

‘This is achieved by raising mortgage rates faster than savings rates in response to Bank of England rate rises – and that’s what we’ve seen since December 16,’ he adds.

‘It would be fatuous to say “savers would have done rather better to use their savings to buy bank shares on 16 December” - taking short term views on shares is risky. But the comparison reveals a kernel of truth.’

The UK stock market is quite financials-heavy – with about 17% of the blue-chip index made up by banks and insurers – so British investors don’t have to look too far for an index fund or more active funds that have high exposure to the sector.

OPTIONS FOR INVESTORS

Jason Hollands, managing director of Bestinvest, said: ‘Owning a low-cost UK tracker, such as the Fidelity Index UK fund, which has a tiny annual running costs of 0.06% on its P shares, will give you a big slug of exposure to financial stocks due to the profile of the UK stock market.’

For investors wanting to take a more punchy approach to UK shares, Hollands highlights the Artemis UK Select fund: ‘The Artemis UK Select fund has an unconstrained, high conviction approach targeting undervalued growth companies and it has delivered a great track record under manager Ed Leggett. Currently financials are a major theme in the fund, representing a whopping 33.9% of the portfolio.’

The fund’s biggest holding currently is Barclays Bank, representing 4.6%.

He added: ‘A combination of high inflation and rising rates isn’t just a UK issue, but a similar story across the globe. One way to play the financials theme globally is through the Polar Capital Global Financials Trust, which is UK-listed investment trust. Two-thirds of the portfolio is invested in banks, with the remainder invested in mixture of diversified financials, insurers and fintech companies - including some exposure to Asia.’

‘The Polar Capital Global Financials Trust is 8% up since 16 December, 50.6% up over the last 12 months, and 114% since the end of October 2020, after which positive vaccine news started to emerge. In other words, in an environment of economic recovery, inflationary forces and rising rates, the financial sector both domestic and global is one of the big winners,’ Hollands concludes.