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It seems that Brexit blues are behind us as of now. The U.K. economy grew 0.3% sequentially in the second quarter of of 2017, unrevised from the preliminary estimate and after a 0.2% advancement in the previous period. Strong government spending and investments made this possible. Household consumption also picked up pace, though sluggishly.

Bank of England (BoE) officials are now bullish on the economy. A senior Bank of England official pointed to the possibility of a rate hike in the coming months for the first time in more than a decade.

The Centre for Economics and Business Research also upgraded the outlook for the U.K. economy on the basis of a rebound in manufacturing activities and a recovery in the consumer spending pattern.

The group now expects the economy to grow 1.6% this year and 1.4% in 2018, which marks an increase from 1.3% and 1.2% expected previously, as per Bloomberg. All these call for small-cap investing as these pint-sized stocks better reflect the domestic economic state.

Consumer prices in the United Kingdom increased 2.9% in August 2017, beating market expectations of 2.8% and following 2.6% gains in the previous month. Higher inflation definitely gives the central bank a leeway to raise rates.

ETFs to Gain

Pound

This rate hike comments led Sterling to vault higher to the highest level since Brexit. CurrencyShares British Pound Sterling ETF (FXB - Free Report) and iPath GBP/USD Exchange Rate ETN (GBB - Free Report) gained meaningfully in recent sessions (read: Is the Bearish Run Over for British Pound ETFs?).

Small-Cap Stocks

iShares MSCI United Kingdom Small-Cap ETF (EWUS - Free Report)

This 265-stock fund looks to track the MSCI United Kingdom Small Cap Index. The fund charges 59 bps in fees. Consumer Discretionary, Industrials, Financials and Information Technology are the top four sectors of the fund. Since small caps better reflect the domestic economic state, these are sure to benefit in a likely rising rate environment. Moreover, large-cap stocks with greater foreign exposure will likely underperform when the pound-sterling is rising (see all European Equity ETFs here).

Will A Rate Hike Be An Easy Task?

Investors should note that this speculation of rising rates may not be a near-term reality, as muted wage increases along with quicker inflation weighed on consumers’ wallets. So, if the central bank hikes rates, growth in Britain will likely be squeezed further (read: How Hard will Brexit be on UK and Pound ETFs).

Plus, Brexit negotiation is a key risk to the economy. Britain had to go through the biggest downgrade of economic growth projections by the IMF for the world's most developed economies this year, thanks to Brexit. In this scenario, the bank of England needs to take a wait-and-see approach before taking the rate hike decision (read: ETF Winners & Losers on IMF Growth Forecast).

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