Investor bets on where UK interest rates will peak have skyrocketed over the past month, prompting an attempt by Bank of England Governor Andrew Bailey not to let markets get carried away.
Futures markets are currently pricing in the BoE interest rate to just over 4.6 percent by December. In early February, rates were expected to peak around the current level of 4% and fall slightly by the end of the year amid fears that the UK was headed for a recession.
This is despite a more mixed mix of UK economic data in recent weeks. Although headline inflation remains in double digits, core domestic inflation – which excludes volatile food and energy prices – fell more than forecast to 5.8 percent in January, from 6.3 percent in the previous month. In contrast, business surveys for February showed a faster-than-expected rebound in activity.
Bailey blasted the rapid shift in expectations this week, arguing that the central bank had “gone off” a “presumption” that more rate hikes were needed. His comments caused interest rate expectations to ease slightly, but traders are still betting that the BoE has turned far more hawkish than it was a month ago.
Some analysts argue that markets are exaggerating bets that UK rates will follow US rates and get significantly higher.
“The consensus seems to be that the BoE will largely mirror the Fed over the next few months,” said Samuel Tombs, UK chief economist at Pantheon Economics. “In the past, however, it was often a mistake to assume that [BoE] will follow the Fed.”
The rebound in UK interest rate expectations in February came after a blockbuster US jobs report in early February that shattered views of a slowdown in economic activity and hopes that the Fed’s aggressive monetary tightening campaign was nearing an end. Traders spent the next month raising their expectations of where US interest rates might peak.
Bailey’s comments “looked positively dovish,” Rabobank analysts said, in stark contrast to officials at BoE peers in Europe and the US, where headline inflation is lower but proving more resilient than previously forecast.
The case for expecting the BoE to stop raising rates soon and ahead of the Fed “remains strong,” Tombs said. Interest rate changes have a “proportionately greater” impact on business activity in the UK than in the US, as most UK corporate bank loans are variable rather than fixed rate and “almost all” UK mortgages have to be refinanced within five years.
These and other differences explain why the Fed last month warned that “continued hikes” would be needed to bring inflation down, while the BoE hinted that UK interest rates may have peaked.
Bailey’s comments this week “make it clear” that the central bank’s monetary policy committee “places more emphasis on the significant tightening already undertaken,” Tombs said, although he didn’t completely rule out the possibility of another quarter-point rate hike later this year.
“It’s rare in the US for Fed officials to exit the markets with their next policy decision in mind,” Tombs said. “But the MPC has a penchant for drama.”
Comments are closed.