Investors shake off BoE governor’s proposal of early rate hike

Interest rates ‘very unlikely this year’: investors say Bank of England needs major inflation shock to hit economy with higher borrowing costs

  • Andrew Bailey said the BoE could raise interest rates earlier than expected
  • But investors think this is unlikely and the increase will happen in February
  • Markets are currently pricing interest rates to rise to 0.5% by November 2022

The Bank of England will not raise interest rates before the end of this year, according to investment experts, despite Governor Andrew Bailey’s aggressive tone.

Bailey raised the prospect of an early rate hike in a speech to the Society of Professional Economists in London last night, saying the monetary policy committee is ready to do whatever it takes to tackle rising inflation.

He said the MPC “believes that the monetary policy stimulus enacted in response to Covid should begin to unwind at some point” [and] that settlement must be ratified by an increase in the bank interest rate’.

Such an increase should not have to wait until the end of the current asset purchase (or quantitative easing) program in December. There are still two options for the MPC to increase the rates this year, namely on November 4 and December 16.

BoE governor Andrew Bailey said the MPC is ready to intervene before Christmas if necessary

The financial markets do not expect any action at either meeting. They are pricing an interest rate hike of 15 basis points in February 2022 and another in November, which would bring the interest rate to 0.5 percent.

The Bank still considers the current rise in inflation to be ‘transient’, even though it expects the rate to rise above 4 percent by the end of the year – doubling the MPC’s target.

However, an inflation shock – which is a growing possibility as energy and food prices are pushed up by supply bottlenecks – could force the MPC to act more urgently.

Michael Hewson of CMC Markets UK said Bailey’s comments show that the “tide appears to be turning” at the BoE, with the MPC “ready to raise interest rates before Christmas if necessary to prevent higher inflation from becoming more persistent.” ‘.

He added: “It seems that some in the MPC are starting to get nervous about a possible rise in wage inflation.”

Bailey balanced his hawkishness by saying that the UK’s economic recovery “has slowed down and the economy has been ravaged by additional shocks”. The MPC recently revised its forecast for GDP growth in the third quarter down from 2.9 percent to 2.1 percent.

CPI inflation rose above expectations to 3.2% in August

CPI inflation rose above expectations to 3.2% in August

The market reaction was muted, with traders becoming more concerned about developments at the US Federal Reserve overnight. British 10-year government bond yields rose 0.04 percentage point to 1 percent, alongside a broader sell-off of government bonds.

Chief Investment Officer at YOU Asset Management Shane Balkham said an interest rate hike in 2021 is unlikely, and the UK would need to “see a significant rise in inflation rates” for that to happen.

He added: ‘Andrew Bailey did what all good policy makers do; make it clear that everything was on the table in terms of tools they can use.

“Saying that interest rates can’t rise until 2022 would have sent a negative signal to the markets, just as Mark Carney wavered when he wanted to raise interest rates after the global financial crisis.”

How investors can prepare portfolios for higher rates

Ben Kumar, senior investment strategist at 7IM, says:

While we don’t expect any movement tomorrow, that doesn’t mean investors shouldn’t prepare for rate hikes and look for opportunities designed to thrive in a rising interest rate environment — even if it’s a matter of years, not months.

For example, we are currently positioned on this by being underweight government bonds, overweight alternatives, overweight value and underweight tech.

“In fixed income, we think investors should also allocate to higher yielding parts of the universe and, where possible, alternatives.

“When interest rates start to rise again – and we believe they will – it will be beneficial to invest in the types of bonds that offer a little more protection in the form of higher coupon payments.

“Government bonds will still protect portfolios, but won’t deliver much in terms of returns.”

Ravenscroft chief investment officer Kevin Boscher agreed that it was “highly unlikely” that the BoE would raise interest rates this year, with the MPC waiting “at the earliest” until November to get a clearer picture of the U.K. economy after the leave and after the October budget.

He said: ‘The number of people who had gone on leave at the end of July’ [the MPC’s] expectatitons. It also made clear that it still considers the recent rise in inflation to be temporary and believes that the recent rise in household inflation expectations is consistent with the fact that they remain anchored.

“A wide range of economic data clearly shows that the global economy is slowing, especially in China and the US. While inflation in the UK and US will remain high for some time to come, mainly due to the continued supply and demand disruption after the pandemic, I believe it will peak and fall back in line in the next six to 12 months. with the central bank’s forecasts.’

For asset manager at Aegon Asset Management James Lynch, the UK job market is the most important factor in forecasting the BoE’s price.

“If the labor market looks robust after the end of the leave and wages are rising, the BoE is more likely to believe this will translate into sustainable inflation (while inflation expectations are currently high),” he explained.

‘As a result, a switch can be forced earlier and/or a switch to higher rates than the market indicates.

‘[The BoE is] still… on the cautious side of waiting for more incoming labor market data, making February more likely than November. But if the data is clear enough, I can’t rule out an earlier move higher.’