Financial markets are wrong to predict the Bank of England will raise UK interest rates by a full percentage point or more by next summer, City economists believe.
asserted
economists → predict → summer
According to market-implied interest rate expectations, the Bank is likely to raise interest rates at least four times over the next year, lifting the bank rate from 3.75% today to 4.75% by the end of July, and possibly to 5% – meaning five rises – by December 2027.
uncertain
Bank → accord → December
But a number of City experts believe such a sharp tightening cycle is unlikely, given there is little sign that the rise in energy costs is pushing up other prices sharply.
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rise → believe → prices
“If you look at the swaps market, and you look at what’s priced in for the Bank of England, you’ve got four rate hikes and then no cuts ever.
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you → look → hikes
And I think you’d be hard-pressed to find anybody that really agrees with that,” said James Smith, a developed markets economist at the Dutch bank ING.
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Smith → think → bank
“By next spring, I think they [the Bank] could be sounding the all clear, and by the end of next year they could be cutting rates again,” Smith told a briefing in the City last week.
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Smith → think → City
Market-implied interest rates are calculated from the prices of a range of financial instruments, including derivatives such as “swaps”, to establish where traders think interest rates will be in future.
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rates → imply → future
Economists cite several reasons why market-implied interest rates expectations are high.
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expectations → cite → reasons
One is that these expectations have been closely correlated with oil prices since the Iran war began.
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war → correlate → prices
The higher oil prices have risen, the more rate increases have been priced in.
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increases → rise → ?
An investor could be right that interest rates won’t rise as far as markets think, but if oil prices keep increasing in the meantime, they would face mark-to-market losses and potentially margin calls.
uncertain
they → rise → losses
“It can get pretty painful, so a lot of traders are quite reluctant to take this risk until there’s greater certainty about energy supply and the extent of inflation this winter,” said Smith.
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Smith → get → inflation
Many traders got burnt at the start of the current Middle East crisis, when most were positioned for further rate cuts this year, he said.
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he → burn → cuts
Sanjay Raja, the chief UK economist at Deutsche Bank, also doubts that the Bank will raise rates as fast as the market pricing suggests.
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pricing → doubt → rates
“I do not believe that any mainstream forecaster thinks the Bank of England will hike to 5% by the end of next year with the information set we have today,” Raja said.
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Raja → believe → information
“It’s not to say it won’t happen.
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it → ’ → ?
But based on current projections, it seems less likely.”
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it → base → projections
He has calculated that a lot of the forecast interest rate rises is actually “baked-in risk premia” – where investors require an extra return to protect them from uncertainty or instability.
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investors → calculate → uncertainty
“Once we strip that out, we have estimated that there is only really ~50bps [half a percentage point] of hikes pencilled in,” he said.
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he → strip → hikes
Deutsche Bank’s base case is for the Bank of England to take the bank rate to 4.25% by next February and then hold rates there until the end of 2027.
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Bank → take → 2027
The Bank of England is widely expected to raise interest rates to 4% at its next meeting, on 5 November, after UK inflation rose further above its target in September to 3.5%.
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inflation → expect → %
Last month Goldman Sachs said its probability-weighted forecast path for the bank rate remained “notably below market pricing”, although it does expect the Bank to raise rates to 4% next month.
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Bank → say → %
But in a new research note, it suggests there could be additional pressure to raise interest rates if the Low Pay Commission recommends a larger increase in the national living wage than expected.
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Commission → suggest → wage
Oxford Economics, a consultancy, also thinks the UK rate-raising cycle will be much less pronounced than what is currently priced into financial markets.
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what → think → markets
“We forecast the [Bank’s] monetary policy committee will raise interest rates by 25bps [a quarter of a percentage point] at its November and February meetings, taking the bank rate to 4.25%.
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committee → forecast → %
This is significantly below the peak in money market expectations, which currently point to the bank rate peaking between 4.75% and 5%,” they told clients last week.
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they → point → clients
Even Huw Pill, the Bank’s hawkish chief economist, has suggested market expectations are running too hot.
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expectations → suggest → ?
He told an International Monetary Fund meeting in Bangkok this month he was sceptical that the Bank would need to raise interest rates four times over the next year.
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Bank → tell → year
The Aporia
