The impact of the Bank of England rate cut on UK stocks

The Bank of England cut UK interest rates to 5% on Thursday, the first cut in four years. But UK stock markets were barely moved by the decision. So what does this mean for UK equities as a whole and sectors exposed to interest rate changes?

• Homebuilders • Hotels and leisure • Consumer discretionary goods • Banks

Mike Koop, chief investment officer for EMEA at Morningstar Investment Management, said the BOE's decision would be broadly favorable for domestic equities.

“That means monetary policy is going to be relatively more stimulative, which is good for equities,” he told Morningstar UK.

Some UK stocks are less sensitive to interest rates

But the overseas profits of Britain's biggest companies complicate the outlook.

“The UK stock market is 80% driven by overseas earnings. So there is a weak link between UK interest rates and UK stock market returns. It's a company-specific issue, there is some domestic play, but the direct link to the UK stock market is not that strong.”

Housing stocks expected to fall

One obvious sector that could benefit from both expected and actual rate cuts is housing. Large publicly traded housebuilders such as Persimmon (PSN) have already seen their valuations rise as a result of this year’s expected rate cuts, which make mortgages more affordable for consumers and lower the cost of debt for companies. Falling inflation and an improving economy have also boosted the outlook for key housing sectors, with recent surveys showing prices recovering.

Laura Paul, portfolio manager at Janus Henderson and manager of Henderson Opportunities Trust (HOT), Lowland Investment Company (LWI) and Janus Henderson UK Equity Income and Growth, thinks the UK housing sector will be one of the main beneficiaries of the rate cut, despite Thursday's modest response.

“[The cut] People are likely to see a slight drop in mortgage rates, which will probably stimulate demand in a modest way again. If you’re a homebuilder and you’re deciding what size of home you’re going to build, you can’t just suddenly build more homes. You have to put stuff in the pipeline,” Foll says.

“If we see demand coming back in a more meaningful way, we are more likely to accelerate our plans to build more homes, which will have a knock-on effect on the building materials sector.”

Abby Glennie, head of small business at Abrdn and lead manager of the gold-rated Abrdn UK Smaller Companies Institutional Income Fund, believes a wider range of sectors beyond housebuilders will benefit from the cuts and is backing estate agent Savills (SVS) and broker Mortgage Advice Bureau (MAB1).

UK stocks: Stars align after election

Despite the property stock rally, Glennie sees the rate cut as another welcome boost to UK equities, which have already hit record highs this year (see Morningstar UK Index chart). For her, it is “another tick in the box” for the improved outlook for domestic equities, including economic growth, a new government and M&A interest.

“We often get asked by our clients: do we need a rate cut to be positive for the UK market? I think it helps, it's a catalyst, but it's not necessary. The UK market can still do well without a rate cut cycle.”

“The best evidence for that is that if you look at the markets since October, small and mid-cap stocks have done well over that period, and not only have there been no rate cuts, but expectations of a rate cut have been delayed.”

Glennie pointed to attractive UK equity valuations, an improving economic cycle, M&A activity and a change in government as contributing factors to his positive outlook for UK equities.

“The rate cut cycle is another tick in the box. The political stability point has been really negative in terms of perceptions of the UK. But when you look at other parts of the world where there are political question marks and the UK looks more stable, what the market likes is stability.”

Focus on consumer stocks and bond agents

According to Hugh Zimmer, global market strategist at JPMorgan Asset Management, the main reason for the rate hike is Britain's performance on inflation.

“As the cost of living crisis recedes, economic momentum is picking up and consumer confidence is returning,” he said.

In this situation, Jimber believes that as consumers have more money in their pockets, the hotel and leisure industries will also benefit by lowering prices.

“But as economic momentum begins to weaken later in the tapering cycle, equity market leadership is likely to shift again, with more traditional 'bond proxy' sectors like utilities and consumer discretionary coming to the forefront.”

Kathleen Brooks, research director at XTB, sees domestic stocks in the mid-cap FTSE 250 as likely to outperform.

“Most indices are heavily leveraged to the real economy. We’ve seen a surge in consumer discretionary stocks. The FTSE 250 is down, but consumer discretionary is holding up, as is property. Those are the two sectors that are most closely linked to interest rates,” she says.

She pointed to the Bank of England's upgraded economic outlook as evidence that the UK economy is recovering from last year's recession.

But if interest rates fall, financial stocks could suffer.

She also believes a series of rate cuts could put the financial sector in a tricky position. Barclays (BARC) was one of the companies that fell on Thursday despite its strong share price performance so far in 2024.

“We have seen Barclays upgrade its estimates for net interest income, which could take a hit as interest rates fall. The fact that the Bank of England has cut its interest rate expectations for the next two years is not good for the financial sector,” says Brooks.

Low interest rates reduce banks’ net interest income, a key indicator for the sector. UK bank shares have performed well this year as “sticky” inflation has delayed rate cuts. Markets have recalibrated their expectations that rates will not fall quickly to pandemic levels and will “stay higher for a long time.” This has supported financial stocks in the US, eurozone and UK, but could start to reverse as monetary policy loosens.

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