In delivering the latest of Bank of England Quarterly Inflation Report, Governor Mark Carney has sought to quash market expectations of an interest rate rise anytime soon by amending previous “forward guidance” which indicated the Bank would only consider raising rates once unemployment fell to 7%.
In so doing, the Bank has essentially messaged that the recovery remains fragile while at the same time notching up GDP forecasts to 3.4% this year. In effect, the Bank is suggesting that while the economy is improving it hasn’t yet reached sufficient “escape velocity” to cope with even a modest increase in interest rates. And for the avoidance of doubt, when rates do rise, they will only do so gradually.
As we have said previously, we have doubts about the sustainability of a recovery that is so heavily anchored to the residential property market and which is being accompanied by high levels of household debt. And today Mark Carney admitted that the recovery is “neither balanced nor sustainable”, with productivity growth continuing to disappoint. Real wages are still below pre-crisis levels, though the Bank expects this to pick up in the second half.
What does all this mean for investors?
With policy remaining accommodative and inflation tamed for now, that should support domestically-orientated equities, so we continue to favour UK mid-caps. Although valuations are far from compelling in this part of the market, these companies should continue to benefit from a cyclical upswing in earnings. We also see increasing evidence that the pick-up in economic activity is benefitting commercial property, with occupancy rates on the high street improving.
Our favoured mid-cap fund is a £70m minnow, the AXA Framlington UK Mid Cap fund, managed by Chris St. John but other funds we like that typically run with a high exposure to mid-caps include Old Mutual UK Alpha, BlackRock UK Special Situations and Standard Life UK Unconstrained Income.
While we favour closed end structures for investments in UK physical properties, the vehicles we like are trading at hefty premiums. We therefore currently favour an open-ended fund, Henderson UK Property, which has a London and South East bias.
Finally, the current domestic recovery comes at a time when traditional corporate bank lending is still constrained and this is providing good opportunities for VCTs to step in and finance smaller companies. These are of course niche investments and only suited to more experienced investors who will benefited from the tax-incentives. For more information on VCTs, visit www.bestinvest.co.uk/vct