Investor expectations for UK interest rate rises have shot up this week following stronger than expected jobs and inflation data, putting the markets increasingly at odds with the Bank of England’s own messaging that it is close to the end of its hiking cycle.
Traders are now pricing in three more rate increases to a peak of about 5 per cent in September, a sharp increase from last week’s expectations of 4.6 per cent, before figures showing stubbornly high inflation took the market by surprise this week.
Annual consumer price rises in the UK failed to dip below double digits in March at 10.1 per cent, and core inflation — which excludes volatile food and energy prices — remained unchanged at 6.2 per cent.
“Inflation is higher than the market was expecting and when you look at the labour market in particular, which is not a source of inflation now but it will be in the future, it also seems to be stronger than previously anticipated,” said Peter Schaffrik, economist at RBC Capital Markets, which increased its forecast for BoE rate increases this week.
On top of high inflation, average earnings excluding bonuses rose 6.6 per cent year on year, according to figures from the Office for National Statistics this week, ahead of a 6.2 per cent increase forecast by economists.
RBC had expected the central bank to hold rates at its next meeting, but has increased its forecast to a 0.25 percentage-point increase in May. Schaffrik said a terminal rate of 5 per cent was “not impossible” as employment data had also been strong in the US and Europe, and banking concerns had faded.
The yield on 10-year government debt has also surged in recent weeks, from 3.4 per cent at the beginning of the month to 3.8 per cent on Thursday, reflecting expectations of higher rates.
Price moves have come despite recent suggestions from BoE policymakers that they are nearing the end of their monetary tightening now that interest rates are 4.25 per cent.
In a speech in early March, bank governor Andrew Bailey signalled he thought financial markets were wrong to believe there was a pressing need for many more rate rises, cautioning markets not to take a firm stance and saying the BoE was now in wait-and-see mode. It had shifted from a previous stance that “further increases in the [benchmark] bank rate would be needed”.
Huw Pill, the bank’s chief economist, said the BoE now needed to exercise “judgment” and should not consider stronger activity to be necessarily inflationary because the reversal of natural gas price rises meant better economic data was not “something inherently inflationary”.
While he indicated that there was still a need to demonstrate the BoE had done enough to defeat inflation, none of his comments suggested an inclination to raise rates to 5 per cent.
While market expectations for rate increases heightened this week, the timing of expected rate cuts hasn’t shifted much, with markets pricing drops around the end of this year.
But Imogen Bachra, head of UK rates strategy at NatWest, said it was “unlikely” the BoE would cut rates as soon as the market expected given “more evidence of stronger underlying inflationary pressures, relatively muted risks so far in the financial system compared to other countries and the fact that the hurdle to easing is higher than it has been in previous cycles”.
Source: Economy - ft.com
