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Aitchison and Colegrave
Investment Overview
November 2003


Rate Rise Is No Surprise, But What's The Impact?

As expected the Bank of England’s Monetary Policy Committee (MPC) voted to increase the cost of borrowing in the UK from the 48 year low of 3.5%, adding 0.25% to raise the rate to 3.75%. The last time the MPC chose to raise interest rates was in February 2000, although the flagging global economy during the subsequent three years has seen interest rates across the world fall as central banks attempted to shore up sluggish economic growth. The decision was widely anticipated by analysts following the continued strength of the housing market and spiralling consumer debt. The minutes of the October meeting showed that four of the nine members of the committee had voted for an increase last month on concerns of rising consumer debt and the strong housing market. In a statement released after the decision the MPC revealed that it felt a "modest" increase in the rate was needed to keep in line with the inflation target rate of 2.5%. Inflation has remained slightly above the Bank of England’s target for the last 12 months and the MPC has concerns over the stimulative nature of current policy. However, we do not expect a significant rise in inflation over the next 12 months.

Further rate rises to come?
It is unlikely that a single increase of 0.25% will be enough to dampen the ongoing boom in house prices and consumer debt/spending. "Neither household spending nor the housing market have slowed by as much as the committee expected," the MPC commented after the decision. While the subsequent comments seemed to be an attempt to re-assure financial markets that back-to-back rate rises were not anticipated, market expectations have currently priced in interest rates at approximately 5% by the end of 2004. "At Charcol Aitchison & Colegrave we are slightly less pessimistic than the current market view and anticipate that interest rates will be raised to 4.5% over the next 12 months," says David Thomson, Head of Investment Services.

Impact of rate rise on bonds
"In the short term it is possible that investors in corporate and government bonds may encounter some volatility, with the potential for some capital loss as markets tend to overshoot following interest rate increases," David explains. "Over the longer term, however, i.e. the next twelve months, we feel that the market has already fully priced in the extent of the UK rate rises." While we have seen a volatile period in corporate bonds over the year so far, corporate bonds are broadly back at the level where they began the year. As we believe that much of the future rate rise expectations are priced into the market the longer term impact on bond prices should be limited, and we feel that at current levels bonds offer reasonable value. Yields have already risen from the lows reached in June as much of the uncertainty that drove the price of bonds, notably the war in Iraq and disappointing economic data releases, have been removed and investor sentiment has shifted back in favour of equities. Corporate bonds have outperformed government bonds throughout 2003 and we currently do not see much further scope for this outperformance to continue. However, "corporate bonds do continue to offer an incremental yield above gilts and therefore a well researched and diversified portfolio of corporate bonds should offer the opportunity to out perform cash and government bonds," David concludes.

CA&C Market Views – By Region

  3 month view 12 month view Percentage Change
Europe Neutral Neutral 11% -1%
United Kingdom Positive Positive 55% +1%
United States Neutral Positive 12% +1%
Far East Positive Positive 6%  
Japan Underweight Underweight 0% -1%
Fixed Interest Neutral Neutral 8%  
Property Neutral Neutral 6%  

Please note that while the above is our indicative asset allocation for a Balanced portfolio your own portfolio may vary significantly due to your own personal circumstances. For specific fund recommendations please contact either your usual Consultant or E-Mail: [email protected].
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This research report is prepared for general circulation and is circulated for general information only. It does not have regard to the specific investment objectives, financial situation and the particular needs of any specific person who may receive this report. Investors should seek financial advice regarding the appropriateness of investing in any securities or investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realised. Investors should note that income from such securities, if any, may fluctuate and that each security’s price or value may rise or fall. Accordingly, investors may receive back less than originally invested. Past performance is not necessarily a guide to future performance.