Bank of England: Letting the arrow take its course

In the UK’s first monetary policy meeting of the year, the Bank of England (BoE) has decided to keep rates flat at 5.25%.

Since August 2023, when the Monetary Policy Committee (MPC) last changed the bank rate, each of the four subsequent meetings ended in a ‘hold’ verdict.

It might feel like the MPC has been doing nothing. But during each meeting, the committee seriously considers several indicators to check whether the current monetary policy is heading towards the 2% inflation target, and that’s no easy task.

The problem with setting monetary policy is that it doesn’t work like a radio, where aiming for a frequency gives us a specific output.

Monetary policy is rather a bit like playing archery or any long-range aiming game. Think of the MPC as the archer, the Bank Rate as the arrow, and the target as inflation, the centre of which is the 2% target.

Archery is, of course, not as simple as pointing and releasing. When aiming, the archer must consider the drag, which will slow the motion of the arrow, as well as the effect of the wind, along with some other factors.

Aiming for the centre of the target at a long distance requires adjusting for these factors, meaning that the journey is not a straight line. And this is what the MPC does: it tries to calculate the speed at which the arrow must travel, while considering all the resistance the arrow will meet along the way; think of this resistance being wage growth, gas prices, production costs, or changes in demand for products and services.

With as much knowledge as it has of all the variables, the BoE has decided to keep the Rate steady as it believes this rate sets the right course for the arrow to land on the 2% inflation target.

What does this mean for 7IM?

Every year, analysts sit in rooms to discuss what they think monetary policy will be like for the year ahead, spending a significant amount of time stress-testing numerous possible scenarios and gauging what is most likely to happen.

The problem with this approach is, of course, unpredictability. If only there was a way to predict what would happen in the world, there would be no need for forecasting. But while it is important to use the past to build an indication of what might happen going ahead, it is equally important to understand the world is in constant change and that predictions are just that.

So when thinking about inflation and whatever moves it – supply and demand, price movements – there must always be room to think about the unexpected. After all, that’s why analysts have jobs: there’s no way to know if a new virus will take the world by surprise, or whether a new geopolitical conflict will change the course of the global economy, but we can certainly try to predict using what we know.

This is only yet another way of saying diversification is important when investing. Preparing for different scenarios is the best way to ensure sustainable growth.

That is what we do at 7IM. Our portfolios are prepared to grow in multiple scenarios, and this is why we’re shielded from whatever decision the BoE might take.

In our diversification strategy, we have a portfolio that contains:

• Exposures to multiple currencies. We want to make sure we’re prepared for any local shocks, so 40% of our Balanced portfolio are in non-Sterling currencies, frequently assessing if we need to change this weighting.
• Geographically diversified equities. We think the economic health of the global economy is important to returns, and therefore we avoid concentration. Only around 10% of the revenues from our equities are UK-related.
• Globally diversified bonds. Our Balanced portfolio contains only about 4% of UK-based fixed income securities – the rest are spread around the world.