Carney's interest rate rise revelation hits FTSE 100

Interest rates are likely to rise in November or December, the first hike in mortgage payments in seven years, after Bank of England (BoE) governor Mark Carney's speech at the Mansion House on Thursday evening.

Chancellor George osborne also poured cold water on the housing market by giving the BoE legal powers to curb excessive mortgage lending by capping on salary and loan-to-value ratios, which led on Friday to drops of up to 5% in the shares of UK housebuilders.

These included Barratt Developments, Persimmon, Bovis Homes Group, Taylor Wimpey, Bellway and Berkeley Group, while Land Securities and British Land fell by a similar level.

Before the speech, markets were pricing in the first rate rise in the second quarter of 2015. Bringing the timeline back has pushed up sterling against most currencies, but hit the FTSE 100 (UKX).

Bad news for equities

Rising rates are typically bad for equities. Higher interest rates are available on fixed income products creating a viable alternative for investors' money. It then becomes a spiral as higher yields encourage investors to save rather than spend, to the detriment of the economy. However, arguably, if rates rise, the economy must be on the mend and that would imply a bull run in equity markets.

This "can't lose" scenario was not lost on analysts, who noted that the risk to their interest rate forecasts is now skewed to an earlier start to hiking, but this also means that the risk to their 2015 growth and inflation forecasts is to the downside.

Nonetheless, many were puzzled by the speed of the volte face. "We have long anticipated the UK policy debate to intensify given surveys suggest the labour market is overheating," says James Carrick, economist at Legal & General Investment Management.

"But with hard data on wages still low in April and the committee undergoing significant changes in personnel, we thought the doves - led by Carney - had won the battle for now and would give growth a chance.

"It is therefore surprising that Carney chose to downplay current low wages by describing them as 'coincident' variables. It implies they will eventually rise in line with stronger, leading indicators.

"Given the BoE only just published a banal inflation report in May, why has Carney become more aggressive a few weeks later? It might be tail risks from Europe. The Inflation Report continues to cite downside risks to UK growth from Europe. Perhaps Draghi's interventions have boosted the [Monetary Policy Committee]'s confidence."

Plenty of caveats

It could be that Carney's speech includes an element of posturing over the timing of the first hike, designed to encourage savers to pay down debt quickly ahead of inevitable rises ahead. There were certainly plenty of caveats. While he highlighted the need for a reduction in household debt, he also noted the impact of a strengthening pound on overseas demand for UK exports, and made a case for retaining a relaxed monetary policy given the fragile economy.

Such a front would be no bad thing. The Resolution Foundation think tank estimates that roughly 3.4 million households with mortgages (38% of the total) have outstanding mortgages of more than three times their net household income.

However, not everyone thinks the wider package of measures will dampen the housing market. Trevor Greetham, director of asset allocation at Fidelity Worldwide Investment, says: "I don't think macro-prudential measures will slow the housing boom effectively and they could actually raise financial risks if they delay a warranted rise in base rates.

"They've been using loan-to-value caps for residential mortgages in Canada since World War II and the jury is still out as to their impact. We haven't got much time to spare with the UK economy growing at 3-4% and unemployment falling sharply. The longer the Bank of England delays actual rate hikes, the higher rates will end up going.

"The economy would most likely stay strong in that scenario but a housing-led downturn could follow some time shortly after the next general election. In the meantime, we remain overweight sterling assets in our multi asset funds and underweight in gilts. A strong pound is a headwind for UK stocks so we see better opportunities overseas."