The Bank of England delivered a shocker today. It increased interest rates to 0.25%, delivering a hike of 0.15 percentage points from the 0.1% level earlier. It was clear for a while that the UK’s central bank would have to raise interest rates sooner rather than later. I have talked about it more than once myself in reflecting on the FTSE 100 stocks I’d like to buy.
Why has Bank of England raised interest rates?
But I doubt that it would have happened so swiftly if we had not received an inflation shock yesterday. Annual inflation based on the Consumer Prices Index (CPI) jumped to 5.1% in November, the highest in more than 10 years. The pressure on prices has been building up for much of the year now. Higher fuel prices, supply chain issues, and demand-supply mismatch in the immediate post-lockdown period have contributed to this.
The Office of Budget Responsibility (OBR) has forecast the number to average at 4% for 2022 anyway, but that was going to be next year. The Bank of England was not expecting this high an inflation number until next year either and the latest print is higher than economists’ expectations of 4.8% as well. This is likely to have prompted the bank to respond sooner than expected on interest rates.
FTSE 100 banks rally
Expectedly, FTSE 100 banking stocks have rallied on the news. Lloyds Bank is the third biggest gainer in today’s trading so far, up by 4.3% as I write. Barclays, Standard Chartered, HSBC, and Natwest are also among the top 10 gainers, showing increases of 4%, 3.7%, 3.6%, and 3.2%. When a central bank raises interest rates, commercial banks are more likely to do so as well. And if their interest rate increases are substantial enough, their financials can look a whole lot better. Going by this logic, I have argued for some time that banking stocks could be the best ones for me to buy at this time.
Are we looking at stagflation, though?
I would do it with some caution now, though. Inflation has been a challenge for many FTSE 100 companies for a while now. At the same time, growth has remained quite muted. In October, the UK economy barely grew from the month before. And with the Omicron variant creating havoc now, growth could be even more uncertain. This is exactly the fear I had earlier in the year, when I had said that we might just be looking at stagflation going forward. And not just in the UK but elsewhere as well. At the very least, we cannot rule it out now. And poor recovery is not good for any sector, and especially not banks, which are cyclical in nature.
I would keep the big potential downside in mind before buying banking stocks. At the same time, I am hopeful that the Omicron virus situation could resolve itself soon enough. This would put the recovery back on track and interest rate interventions should impact inflation too. But for now I am waiting and watching what happens next, not buying anything. If things do get back on track quickly however, I’d buy banking stocks.
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Manika Premsingh has no position in any of the shares mentioned. The Motley Fool UK has recommended Barclays, HSBC Holdings, Lloyds Banking Group, and Standard Chartered. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.