First Bank of England Rate Rise in a Decade – A Sign of Things to Come?
Earlier today, the Bank of England Monetary Policy Committee voted 7 to 2 to raise base interest rates from 0.25% to 0.5% – the first rate hike in a decade.
This was widely expected by the market which had priced in a c.90% probability for a rate rise at close of business yesterday. It follows a degree of careful messaging from the Bank of England released over the past couple of months and is in line with Centrus’ house view published in September. Gilt yields tightened following the announcement, with the 5 year yield falling by c.9bps:
The significance of this historic rate move should not be underplayed, but neither (in our view) should it be over-emphasised. The key question it raises for us and our treasury clients is – is this the first of a cycle of near term rate hikes? Or is it simply a cautious first step away from a zero/negative rate environment and a way for the Bank of England to test the market’s reaction, having witnessed the “taper tantrums” of previous years when global equity and bond markets reacted badly to the idea of the withdrawal of the Federal Reserve’s bond purchase programme?
In our opinion, the answer most likely lies in between these two alternatives – the upward pressures on rates are still strongly counteracted by significant future uncertainties facing the UK economy.
Hawkish signals contributing to this decision were:
- Increasing inflation – 2.8% CPI inflation in September, 0.8% above the Bank of England target. The MPC expects October inflation to hit 3.2%, which in part is due to rising oil prices (which reached $60p/barrel yesterday)
- Strong GDP growth of 1.5% annually, and 0.4% vs the previous quarter
- Unemployment falling to 4.3%, the lowest level since 1975
- Sterling weakness compounded by higher USD interest rates and ECB tapering.
The uncertainties which we think would limit further rate rises are:
- Brexit uncertainty, with no clear view as yet on whether it will be a “Hard” or “Soft” exit from the EU.
- Real wages fell 0.4% year-on-year
- Uncertain real estate market – London property fell 2.7% last month (the largest drop since 2009), and Jones Lang Lasalle forecasts zero London real estate price increases for next year.
The rates decision is clearly a turning point, but we recommend our clients take a cautious approach and shy away from any reactionary moves. As always, here at Centrus we will continue to monitor the interest rates, inflation, credit and foreign exchange markets for emerging risks and opportunities presented to our clients.