Interest rates will rise tomorrow – but what next?

It seems almost certain that interest rates will rise to 5.75% tomorrow and they're unlikely to stop there, says John Stepek. As yet another subprime hedge fund bites the dust, the global credit crunch looks to be upon us.

This feature is part of our FREE daily Money Morning email. If you'd like to sign up, please click here: sign up for Money Morning

Today the Bank of England meets for what may well be a slightly awkward meeting.

The Monetary Policy Committee is clearly divided on what it reckons the economy needs. The 5-4 split last time attested to that.

Subscribe to MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

But most of last month's hold' voters if not all are likely to vote for a hike this time round. The main objection last time was that a raise last month might have surprised markets, whereas they're all expecting one this month.

So it seems certain that interest rates will rise to 5.75% tomorrow. But what happens next?

At first sight, some might argue that there's no need to raise interest rates. Rachel Lomax, the Bank's Deputy Governor, certainly feels there's no need to rush. Inflation has eased back from the target-busting 3.1% seen in March, to 2.5% in May, while it seems that consumers are already feeling the squeeze from rising rates.

Retailers have been sounding more cautious in recent weeks, while brewery Scottish & Newcastle warned yesterday that first-half profits would be weaker than expected. Total UK beer sales have fallen 5% this year the company put the blame on bad weather (which for once, might be more than just an excuse), but it seems likely that worries about making household budgets balance won't have helped.

However, Mervyn King and the MPC members who voted with him last month clearly and rightly - believe that credit conditions are still too slack. With house price growth still strong (there are signs of turning, but most property companies have good reason to try to make the market look as bad as possible, in the hope of unnerving the MPC), Mr King and his colleagues will try their very best to avoid making the mistake the MPC made in August 2005, when a hugely premature quarter-point cut in rates reinflated the housing bubble.

Other reports also suggest that inflation is still much more of a worry than official figures might suggest. The Telegraph reports that "food prices and energy bills are rising faster in Britain than almost anywhere else in the world", according to an OECD report. Shoppers are shelling out nearly 5% more for their weekly shopping than they did a year ago.

And the most recent manufacturing survey, from June, shows that manufacturers are still having little difficulty pushing through price increases. Paul Dales of Capital Economics reports that the survey suggests that "the hawks are likely to have the upper hand when the MPC votes on Thursday, and probably in the months thereafter too."

As Roger Bootle (also of Capital Economics) commented in The Telegraph on Monday, "rates will rise to 5.75%. But they won't stop there. Reach for your tin hats."

Meanwhile, in the ongoing subprime saga, another hedge fund has come a cropper Florida-based United Capital Asset Management has stopped investors from taking their money out of its Horizon ABS funds, "after heavy losses trading subprime bonds and derivatives", says the FT.

Redemption requests included one from "the fund's largest investor, who accounted for almost a quarter of the fund's assets under management." As of the end of last month, the Horizon funds were down 15%, "but sources said that 15% was a loose estimate and the value of the holdings could be revised down further."

A squeeze on the consumer, a squeeze on hedge funds it's looking more and more like the global credit crunch is upon us. So where can you invest? Well, the experts at our latest Round Table might be divided about the prospects for the global economy, but they do have some very interesting small-cap stock tips that should perform well regardless of the economic weather. You can read all about them in the latest issue, out on Friday.

If you're not already a subscriber, you can sign up for a three-week free trial of the magazine, just by clicking here: Sign up for a three-week free trial of MoneyWeek.

Turning to the wider markets

Enjoying this article? Why not sign up to receive Money Morning FREE every weekday? Just click here: FREE daily Money Morning email

In London, all the major indices closed higher yesterday, with the FTSE 100 index of leading shares adding 49 points to end the day at 6,639. An announcement by pub group Greene King that it is to team up with a specialist property partner boosted the share price of peers Enterprise Inns and Punch Taverns. The latter topped the FTSE leaderboard with gains of over 3%. For a full market report, see: London market close.

On the Continent, the Paris CAC-40 fell 5 points to end yesterday at 6,069. In Frankfurt, the DAX-30 was 65 points higher, at 8,050.

Across the Atlantic, US stocks extended Monday's gains as investors were cheered by merger news. The Dow Jones added 41 points to close at 13,577. The tech-heavy Nasdaq was 12 points higher, at 2,644. And the S&P 500 was up 5 points to end the day at 1,524. US markets are closed today for the Independence Day holiday.

In Asia, the Japanese Nikkei notched up its fifth straight day of gains, adding 18 points to close at 18,168.

Crude oil was trading at $71.24 this morning, whilst Brent spot was at $73.51 in London.

Spot gold had risen to $654.25 this morning as a combination of security concerns, the higher oil price and the weak dollar prompted buying (for more on gold, see our daily gold market report). Silver was also higher, at $12.60, this morning.

In the currency markets, Sterling breached the $2.02 mark against the dollar this morning on expectations of a Bank of England rate hike tomorrow, but had since fallen back to $2.0175. The dollar was trading at 0.7342 against the euro, not far off a record low, whilst the pound was at 1.4816 against the euro. And the dollar was at 122.38 against the Japanese yen.

And in London this morning, hotel groups were heading higher as the sector is bolstered by news that US private equity group Blackstone is to buy the Hilton Group for $26bn. Intercontinental had risen by as much as 5.4% in early trading, making it the FTSE 100's top gainer of the day so far.

And our two recommended articles for today...

How indebted Americans are giving up their independence

- Today is American Independence Day, but many US consumers have sacrificed their financial independence in order to live more extravangantly than they can afford. For more on why record consumer debt and an $800m trade deficit could rob the country of its reputation as the land of the free, read: How indebted Americans are giving up their independence

Why oil investors are still smiling

- The oil price still hasn't peaked - and that means there are rich gains to be had by investors. In this MoneyWeek article - just available to non-subscribers - we pick two of the best buys in the stockmarket and suggest where the industry's brightest new prospects are to be found: Why oil investors are still smiling

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.